Stabilization Policy

December-05-08
8:44 AM

Definition: A government policy designed to lessen the effects of the business cycle.
Goal: Is to keep the economy as close as possible to its potential output. Natural unemployment exists -
inflation is restrained

Two Categories:
- Expansionary policies
- Contractionary policies

Expansionary Policies

- Our government policies designed to reduce unemployment and stimulate output

- When total output is below its potential, policy-maker want to eliminate the recessionary gap

Contractionary Policies

- Our government designed to stabilize prices and reduce output

- The economy is booming, policy makers want to cut the inflationary gap - (to stabilize prices and bring
the economy back down to its potential output)

Fiscal Policy

- "Fiscal" - budgetary
- Definition: Government stabilization policy that uses taxes and government purchases as its tools:
budgetary policy
- Governments have an extensive impact on the economy through taxation and government purchases.
The government's annual budget sets out what the government will tax and spend.
- The budget becomes an instrument of stabilization policy
- Fiscal Year: the 1-month period to which a budget applies

Discretionary Fiscal Policy

- Is when the government takes deliberate actions through legislation to alter spending or taxation
policies in order to influence the level of spending and employment
- Discretionary fiscal policy occurs when the federal government takes on an active role in the economy
by increasing or decreasing government spending or tax policy.
- Non-discretionary fiscal policy is active accounts or stabilizers that are set up to operate even when the
government does not takes on an active role in the economy.

Uses of Fiscal Policy

FISCAL POLICY OPPOSITE OF BUSINESS CYCLE if POLICY IS CONTRACTIONARY then BUSINESS

CYCLE IS AT EXPANSIONARY

EXPANSIONARY FISCAL POLICY

1. Expansionary Fiscal Policy:

i. Government policy that involves increasing government purchases, decreasing taxes, or
both to stimulate spending and output.
1) This would entail a tax cut, an increase in government spending, or both
2) To stimulate economic growth and lower employment (PST - 8%, GST - 5% was 7%)
○ Expansionary discretionary Fiscal Policy
i. The economy is in an economic contraction. Most likely it is in recession. AT this time the
government will enact policies to reduce the recessionary gap and spur economic growth

Unit 3 - Fiscal Policy Page 1

 government will enact policies to reduce the recessionary gap and spur economic growth
○ Increased Government Spending
i. The government increase spending which should increase aggregate expenditure
ii. As G + AD + Q + Employment + Y + P + (+ = increases)
○
i. Decrease taxes
ii. The government will reduce personal or corporate taxes which should increase aggregate
expenditure
iii. As T - C + AD + Q + Employment + Y + P +
iv. These two policies could also be run together at the same time
2. Contractionary Policy:
a. Government policy that involved decreasing government purchases, increasing taxes, or both to
restrain spending and output
b. The economy is in an economic expansion. Most likely it is in a boom. At this time the government
will enact policies to reduce the inflationary gap and spur stable but slower economy growth
c. Decreased Government Spending
i. The government decreases spending which should decrease aggregate expenditure
ii. As G - AD - Q - EMPLOYMENT - Y - P -
iii. Increase Taxes
iv. The government will increase personal or corporate taxes which should decrease aggregate
expenditure
v. At this point the teacher will try to involve students the below analysis
vi. As T + C - AD - Q - EMPLOYMENT - Y - P -
vii. These two policies could also be ran together at the same time
d. Automatic Stabilizers:
i. Certain elements in the economy tend to stabilize our growth. These items were up to set
up to automatically work when the economy grows too fast or contracts too fast. The
government established them.
ii. During a boom, these stabilizers will try to decrease Y, P, Q, and employment
iii. During a recession, these stabilizers will try to increase Y, P, Q, and employment
iv. In a period of contraction, net tax revenues .(taxes minus transfers and subsidies) decrease.
v. During a period of expansion, NET TAX REVENEUE increases

Examples of Stabilizers:

a) Income Tax:
a. The Canadian income tax system is a progressive system, meaning as incomes increase people pay
a higher total tax and also a higher tax rate. So in a boom as incomes go up the government
automatically collects more taxes from its people.
b. As incomes decrease people pay a lower total tax rate and also a lower tax rate. So in a recession
as incomes go down the government automatically collects fewer taxes from its people, giving
them more to spend.
b) Social Security Payments (welfare):
a. During a recession as people lose their jobs and become unable to find work. The can collect
welfare, so that they still have money to live with.
b. During a boom when people start to find work they are automatically cut off of welfare. They have
less money to spend.
c) Price Support Programs:
a. This is a program implemented by the federal government of Canada that is used to give farmers
aid. When farm output starts to receive a lower price. The government will use some artificial
means (grants) of increase the price farmers receive. These way farmers receive enough money to
continue their operations. They do not go out of business. When there are booms and farm
product prices go up, the price programs do not work.

Unit 3 - Fiscal Policy Page 2