Fiscal Policy

Siny Joseph, Kansas State University,
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Summary

Students will be able to evaluate the implications of government spending versus tax cuts to shift the AD curve in response to the 2007-2009 recession.

Context for Use

This activity is appropriate for principles course.
Students need to have prior knowledge about multipliers, and aggregate demand and aggregate supply.
There are no class size limitations.
This activity can be completed in one class period of 50 mins.

Overview

This activity expects students to be familiar with fiscal policy, and the concept of marginal propensity to consume. They will be evaluating the impact of government spending relative to tax cuts to shift the AD curve during the 2007-2009 recession. This activity will also help students identify the concept of multipliers in choosing between the fiscal policy tools.

Expected Student Learning Outcomes

By the end of this activity students will be able to evaluate fiscal policy tools- tax cuts versus increases in government spending.

Information Given to Students

Assume you are a member of the President's Council of Economic Advisors tasked with recommending a response to a major recession. The goal is to shift the AD curve and the government is debating between policy options of an increase in spending or a tax cut. What policy option would you propose?
a. Tax cut is more powerful than government spending.
b. Government spending increase would be far more effective over a tax cut.
c. A mix of both government spending increase and tax cuts would be most appropriate.

d. Federal debt is too high. Rely on Monetary policy alone.

Teaching Notes and Tips

Team reporters will be expected to have supporting analytical work in their individual notes. They will need to draw the AD-AS framework and illustrate the impact of the policy.

Instructors should review the concept of multipliers and AD-AS framework prior to this activity.

Have a team reporter explain in words how they arrived at their choice. Circle back and get other team reporters to provide the analytical support at the doc cam or on the chalkboard. Have team reporters try to convince each other.

Facilitation questions specific to the exercise will be to ask team reporters to identify political pressures that constrain the choice. Offer the information that in 2009, the stimulus package was a mix of spending and tax cuts. Instructor should ask students why that occurred, given the spending would have had a bigger effect at closing the "output gap." Provide hypothetical numbers to work through the appropriateness in the choice of government spending and tax cuts. Students may lean towards option C as the right answer. If the MPC is less than 1 then some of the tax cut is spent, and some of the tax cut is saved leading to a tax cut that needs to be greater than government spending to accomplish the same level of shift in the AD curve.

Assessment

In early January, 2009 President-elect Barack Obama put forward a $775 billion stimulus plan intended to bring the U.S. economy out of a deep recession. It was estimated there was an "output gap" of $2 trillion of what the American economy can produce and what it's able to sell. According to economists, a dollar of public spending raises GDP by around $1.50.

a. Barack Obama's stimulus plan was too large.
b. The stimulus plan was too small
c. The stimulus plan was just about right to bring the U.S. economy out of recession.
How large would the stimulus package need to be to close the recessionary gap?