Fiscal policy actions: Expansion and contraction

0:00- [Narrator] When people think about ways that broadly the government or kind of the government can affect the economy, they'll talk about fiscal policy. They'll also talk about monetary policy. We talk about monetary policy in more depth in other videos. Monetary policy comes from the central bank, which in the United States is the Federal Reserve.

0:18And that usually relates to interest rates and the quantity of money and how money might enter into the system, while fiscal policy is usually about budgets. This is the government, and the budgets are set by the legislative branch, and then the president, in most cases has to sign off on it.

0:36But because of budgets and how much they are spending, they can decide how much money to inject into the economy or to take out of the economy based on whether they want to stimulate or they want to restrict the economy. And a lot of these ideas come from, and we talk about this in other videos, John Maynard Keynes, who ha brought up this idea that the government could use its budget and its spending in order to contract or to stimulate the economy.

1:03So what are the general rules of thumb here? Well, let's imagine that we are in a recession. So the economy is really slow here. People aren't spending money. There's a lot of unemployment. Companies aren't investing, everyone is afraid to spend. Well, in this situation, the government, and this is what Keynes suggested, should spend money or should insert money into the system.

1:27It might not be the government necessarily spending it. That's one way to do it. So you could say more government, more government spending, spending. But another way to insert more money into the economy is also to cut taxes. The stereotype is typically that on the left, the reaction is maybe to spend more, while on the right, if we're talking about politically, the reaction is more to cut taxes.

1:57But that's not always the case because if you're in a recession and the economy on its own, or people and businesses on their own aren't spending money, well now the government might want to do that and might get that flywheel of the economy going. Well, let's imagine we're in the other extreme where we're in an overheated economy, so, overheated.

2:17And what do I mean by overheated economy? Well, this could be a situation where there's a lot of inflation. There's just, almost, the economy is operating above its potential. Prices are going up a lot, and inflation itself can be a very negative thing once it starts going.

2:34I'm not gonna go to a lot of depth here. And so in this situation, there might be an interest in taking money out of the economy. So this might be a situation where you have less government spending or you could take more money out of the system by raising taxes.

2:55So these are just the general rules of thumb. Good to keep in mind. Remember, this is only on the fiscal policy side. We, in other videos, we will talk about the monetary policy side, but it's also a similar idea that when you're in a recession, on monetary policy, you wanna somehow get more money into the system or more people borrowing money and spending it, and when there's inflation, you might want to have, from a monetary point of view, you might wanna take money out of the system somehow and have less borrowing or maybe make the cost of borrowing higher.

3:24But we'll talk about it in another video. This is just what the government can do with taxes and its budget.