Name:  ____________________________
Course: ____________________________
Instructor: __________________________ 
Date: _______

Focus on Fiscal Policy

NOTE:  It is highly recommended that you read over this entire lesson before you begin.

Preliminary Discussion:  Fiscal policy refers to government spending and taxation.  Governments can use fiscal policy as a counter-cyclical tool, because changes in government outlays and taxes affect aggregate demand and aggregate supply.  It has been regarded as a major policy tool ever since John Maynard Keynes advocated the use of fiscal policy to get out of depression in his book, The General Theory, published in 1936.

According to Keynes, market economies had a proclivity to fall into depression when consumer and business spending declined.  Instead of waiting for self-correcting market mechanisms to work, Keynes advocated deliberate deficit spending by the government to stimulate aggregate demand.  This would immediately create jobs and incomes for otherwise unemployed workers.  The classical school of economic thought had theorized that market economies would automatically restore full employment in the long run.  Keynes retorted that in the long run we're all dead.

When the government spends more than it receives in taxes, it borrows and adds to the national debt.  When it receives more in taxes than it spends, the surplus can be used to pay down the national debt.  Using fiscal policy as a counter-cyclical tool to promote full employment and price stability with little or no regard for its effect on the national debt is known as functional finance.

During the 1980s and 1990s, entitlement programs began to consume a greater percentage of government outlays in the highly developed industrialized countries.  Accordingly, the discretionary portion of government budgets to provide public goods and services diminished.  Also, the budgetary process itself is very political.  For these reasons, fiscal policy can be subject to policy gridlock and significant delay before new spending programs and tax policies can be implemented.  This hinders the timing and effectiveness of fiscal policy.

In The World Game of Economics you are the chief economic adviser to the leaders of the country of your choice.  You are in charge of economic policy, including fiscal policy.  The objective is to implement timely and appropriate economic polices to improve the overall economic performance of your country.  Good luck and have fun!

1.  Play The World Game of Economics to 100 points against up to six other countries that are either computer-managed (i.e., advised by Professor N. D. Cator) or Laissez Faire.  Note:  If you do not know how to play the game, then select "Tutorial" from the main menu first.  If you already know how to play, then select "New Game."

2.  You are the chief economic adviser to which country?  _______________________.
3.  How many other computer-managed countries are you playing against?  ________.


4.  Which year have you chosen to complete this exercise?  __________.
5.  Look at the Aggregate Demand and Aggregate Supply diagram below.  Assuming your economy is at E0 at the beginning of your turn, which direction is the Economic Indicator currently pointing:  (Circle One)

                                     E1     E2     E3     E4     E5     E6     E7     E8

6.  Which change or combination of changes in Aggregate Demand and Aggregate Supply does the direction of the Economic Indicator predict?  (Circle One)

+AD    +AD&+AS    +AS    -AD&+AS    -AD    -AD&-AS    -AS    +AD&-AS

Now click on ECONOMIC INDICATOR and the CURRENT EVENT.  Click on ECONOMIC POLICY and go to the Policy Board.

7.  On the template below, indicate where your economy is currently positioned before selecting your fiscal policy.  Use a pen to sketch your country’s flag or print an abbreviation (e.g., USA = United States).  Note:  If you know how to use "Print Screen" tools, then use that method and attach to this exercise  Circle the current position of your country.

8.  Considering the current location of your country and assuming you had all the options, which Fiscal Policy would you advise your country's leaders to undertake at this time?  (Circle Only One).

+GS     -GS     +T     -T     +E     -E     +IR     -IR     none/pass

9.  Is your preferred Fiscal Policy available to you at this time as one of your options?  ___Yes or ___No.

NOW SELECT YOUR FISCAL POLICY.  SELECT THE REST OF YOUR POLICIES. COMPLETE THE GAME.  Print the final score and attach it to this exercise.

ANSWER QUESTIONS 10 - 14.  (Circle the letter before the best single answer).

10. The term functional finance refers to:
(a) balancing the budget over a period of ten years.
(b) balancing the budget each year.
(c) using discretionary fiscal policy to achieve macroeconomic goals even if the budget doesn’t balance.
(d) balancing the budget over the course of one business cycle.
(e) never balancing the budget.

11. An increase in government spending for public goods and services:
(a) initiates a multiplier effect which results in a cumulative increase in total spending that is greater than the initial change in government spending.
(b) is always undertaken when the public wants more government services.
(c) should be accompanied by an equal increase in taxes, so that the budget remains in balance.
(d) is an effective policy tool when the economy is in Stagflation.
(e) is ineffective if the budget is already in deficit and the economy is in Depression.

12. Generally speaking, the tax multiplier for a decrease in taxes is weaker than the government spending multiplier, because:
(a) paying taxes is voluntary.
(b) the underground economy avoids paying taxes through tax loopholes.
(c) income taxes can be passed on to somebody else.
(d) part of a tax cut will be saved.
(e) politically, it's not as easy to cut taxes as it is to cut government spending.

13. The crowding-out effect refers to:
(a) the fact that deficit spending and increasing the national debt necessarily passes on costs to future generations in the long-run that are greater than the short-run benefits.
(b) the empirical evidence that deficit spending doesn't work as well when there is a rapid increase in population.
(c) the hypothesis that an increase in private sector spending "crowds out" the effectiveness of government programs.
(d) the notion that increasing taxes and government spending at the same time has no effect on total spending, because the two policies offset each other.
(e) the theory that an expansionary fiscal policy at or near full-employment will increase interest rates and cause private sector spending to decline.

14. In The World Game of Economics, your best strategy over the course of a game is:
(a) to never pass on fiscal policy, because it will always improve your score.
(b) to avoid getting stuck with policy gridlock as your only fiscal options.
(c) to increase government spending whenever you can.
(d) to cut taxes whenever the economy is growing too fast.
(e) to balance increases in government spending with increases in taxes.

End of Lesson 6

Note:  At the instructor's discretion, you will receive _____ possible points for this exercise.

Instructor's Option:  At the instructor's discretion, you may receive additional points according to the schedule below.

Number of Other Countries
Your Place

Examples:  If you play against 6 other countries and you place 1st, then you get 10 extra points!  If you play against 4 other countries and you place 3rd, then you get 6 extra points.  If you play against two other countries and you place 2nd, then you get 5 extra points.  In each case if you place last, then you get only 4 more points.

Winning Strategy Hints:  Winning strategy involves anticipating the Economic Indicator, playing your policy options efficiently, coordinating your range of policies, and using trade policy to prevent one country from getting too far ahead.  Consider your opponents’ options and try to anticipate their trade policies.  Keep in mind that countries tend to use trade restrictions, tariffs, and currency devaluations when they have high unemployment. Be careful not to get caught having too many inappropriate and useless options.  Discard policy gridlock and foreign policy conflict options as frequently as possible.  [You don’t want to be trapped in a Depression like the United States in the 1930s or caught like Germany in Hyperinflation in the early 1920s].  Study the probabilities that are provided in the instructions.  That will help you plan your strategy.

Global interdependency is portrayed both indirectly and directly in The World Game of Economics.  Indirectly, when the Economic Indicator changes direction for one country,  it changes direction for all the other countries.  This demonstrates how economic recessions and recoveries are internationally contagious.  When one country’s economy expands (or contracts), it begins to import more (or less) from other countries.  Directly, one country’s trade policy affects another country.  The two countries move in opposite directions.  For example, when one country depreciates its currency vis-à-vis another country’s currency, exports increase in the former and decrease in the latter.

When planning your trade policy strategy, recall the other countries’ monetary policies.  Note the direction of the Economic Indicator and consider which countries are leading in the game score.  Try to move those countries away from the center at the same time that you improve your own country’s position.

The World Game of Economics   (C) 1999 Ronald W. Schuelke   All Rights Reserved