Introduction to Unit 9 - Fiscal Policy and the Internet Economy

Given an understanding of the business cycle, we can now expand our knowledge to better comprehend how economic policy makers deal with business cycles. In general, economic policy makers try to reduce the negative consequences of the business cycle without causing alternative problems as a result of their actions. For example, a reduction in the unemployment rate should not come at the expense of a boost in the inflation rate. As you may already have deduced, this is easier said than done. Our basic framework of analysis is the graph of aggregate demand and aggregate supply shown here.
As shown graphically, depending on the relation of aggregate demand to aggregate supply, a policy that encourages faster aggregate demand growth can have the undesired consequence of higher inflation rates.

In this section we will cover the basics of fiscal policy. Fiscal policy is carried out by the executive and legislative branches of government, and refers to tax policy and government spending on goods and services. Revisiting our equation for GDP that can be written as:

GDP = C(Y - T) + I(r) + G + NX

Consumption (C) is a part of our disposable income or, total income minus taxes (Y - T). Fiscal policy deals with changes in taxes or the tax rate (T), that in turn affects total consumption. Or, fiscal policy can directly alter the growth rate of GDP and aggregate demand by changing the level of government spending (G).

An expansionary fiscal policy would be used to speed up the rate of GDP growth or during a recession when GDP growth is negative. A tax cut and/or an increase in government spending would be implemented to stimulate economic growth and lower unemployment rates. These policies will lead to higher federal budget deficits.

A restrictive fiscal policy involves raising taxes or cutting government spending in an attempt to dampen GDP (aggregate demand) growth and lower inflationary pressures.

Beyond the basics, we won't go much further into fiscal policy. Part of the reason is that discretionary fiscal policy has only a minor role when dealing with the economy. This is a result of the tremendous federal budget deficits present during the 1980s and 1990s, and the rapid accumulation in the national debt. The White House and Congress have made deficit reduction the primary focus of fiscal policy and let the Federal Reserve take the economic reigns.

This section will begin with a bit of economic history and the development of what is known as Keynesian economics that emphasizes the use of discretionary fiscal policy to counteract the undesirable consequences of business cycles.

This section also covers potential impacts of the Internet on macroeconomic activity. A good argument can be made that as the Internet develops, the annual rate of increase in worker productivity will improve resulting in a higher rate of non-inflationary growth.

LINK TO MAIN SECTION OF UNIT 9 - FISCAL POLICY AND THE INTERNET ECONOMY