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- [Tyler] When the recession of 2009 hit,
the federal government tried to stimulate the American economy.
It cut taxes and increased spending.
In other words, it conducted expansionary fiscal policy.
Fiscal policy -- the government's policies
on taxes, spending and borrowing --
that's used to try to mitigate fluctuations in the business cycle,
to even out the booms and the busts.
But, how is it that expansionary fiscal policy
is capable of actually working?
Imagine an economy that's operating at full employment.
Workers have jobs,
and factories are operating near capacity.
If in that case, the federal government tries
to increase spending to, say, build a new road,
then it necessarily has to take away some people and some capital
from other sectors of the economy.
GDP wouldn't increase,
because there's already full employment.
So government spending would simply be crowding out
private spending and investment.
Building the new road?
It may or may not be a good idea,
depending on how valuable that road would be.
But still, the increased government spending would not,
in the short run, stimulate the economy.
But now, in contrast,
imagine an economy during a recession.
The fundamental factors of production are underused.
Labor and capital are unemployed or underemployed.
Machines and buildings are idle.
In this case, government spending on a new road
probably would increase GDP.
In fact, an extra dollar spent during a recession
might even increase GDP by more than a dollar.
Say, for instance, the government hires
unemployed construction workers.
These construction workers then use their new income
to, say, eat out at restaurants.
This causes restaurant owners to hire more workers,
and these newly employed waiters and waitresses --
they then spend their money throughout the economy.
There's a kind of ripple effect,
and the people who receive that money
in turn spend more money themselves.
The subsequent increases in spending
caused by the initial increase in government spending --
that's known as the "fiscal multiplier."
Now, expansionary fiscal policy
is not the only kind of fiscal policy.
The government also conducts contractionary fiscal policy
by saving during an economic boom --
by either increasing taxes or by decreasing spending.
At least that's how fiscal policy is supposed to work.
Later, we'll discuss some of the political economy issues
of continual deficit spending
and why government surpluses sometimes are so hard to come by.
- [Narrator] You're on your way to mastering economics.
Make sure this video sticks by taking a few practice questions.
Or, if you're ready for more macroeconomics,
click for the next video.
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