About this video
Sal adds the second fiscal policy tool: besides raising government spending with taxes held constant, a government can hold spending constant and lower taxes. Both are usually financed by more debt, and lower taxes leave consumers and firms more to spend, raising consumption and investment and therefore GDP.
You'll be able to
- name two fiscal policy tools: changing government spending and changing taxes.
- explain which GDP components rise when taxes are cut.
- explain why both tools usually require more government debt.
Key words
- Fiscal policy
- A government's use of spending and taxes to influence the economy.
- Government debt
- Money a government has borrowed and must pay back.
- Consumption (C)
- Spending by consumers and households on goods and services.
- Investment (I)
- Spending mostly by firms, plus consumer spending on new houses.
Transcript
Voiceover: I want to do a quick follow-up to the last video because I did not give a complete picture of all of the fiscal policy tools that a government has at its disposal. What I focused on in the last video is a government that holds taxes constant, taxes constant, and increases spending.
Spending goes up. The only way that a government could do that is by taking on more debt, or I guess if there are some governments that are saving, saving less, but most of them, they're going to have to take on more debt. So they're going to take on more debt.
Just to think about it in terms of the, in terms of the GDP expenditure components, we know that GDP, GDP is equal to consumption, which is mostly consumers, individuals, investment, which is mostly firms, and some consumer spending on new houses. Then you have government expenditure, and then you have net exports, which kind of completes the picture.
But what we described in the last video is these two things are held constant. Taxes don't change. People, the government isn't fueling its expenditures with more taxes, so this part stays constant, but with the extra debt, the government spends more, so this part goes up, everything else holds roughly constant, and so GDP would go up.
The other tool that the government has, has at its disposal, is to hold spending constant, so spending is held constant, and lowering taxes, and lowering taxes, which would essentially put more money in the hands of consumers of individuals, families, and firms.
Once again, the only way they can do that, if you hold spending constant, and you're reducing your revenues, the only way they can do that is once again, taking on more debt. This is a common theme here. They would have to take on more debt, assuming they don't have any savings to kind of eat up, to finance this type of thing.
Looking at this again, we have GDP is equal to consumption plus investment plus government spending plus net exports, plus net exports, in this situation, government spending is held constant but because the consumers' and the firms' taxes have gone down, they have more to spend, and they will spend some component of it, and so these two pieces will go up, and GDP will go up.
I just wanted to make sure we added this picture right over here. Fiscal policy isn't just about increasing or decreasing government spending. It can also be about tax policy, increasing or decreasing taxes.
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