5 Steps to a 5 AP Macroeconomics 2019

Fiscal Policy, Economic Growth, and Productivity ❮ 133

When the price of a dollar rises from E 0 to E 1 , it now becomes more expensive for

foreign citizens to buy goods made in the United States. All else equal, net exports in the

United States fall when the dollar appreciates in value. Falling net exports decreases AD,

which lessens the impact of the expansionary fiscal policy. This would be seen in much the

same way as in Figure 10.5.

If the government is using contractionary fiscal policy to fight inflation, and interest

rates begin to fall, the demand for dollars falls, depreciating the dollar and increasing net

exports. This increase in net exports lessens the effectiveness of the contractionary fiscal

policy.

•   Expansionary fiscal policy is less effective if government borrowing crowds out private

investment with higher interest rates.

•   Expansionary fiscal policy is less effective if net exports fall because of an appreciating

dollar.

•   These effects also work in the opposite direction, making contractionary fiscal policy less

effective when interest rates fall.

State and Local Policies

The U.S. Constitution does not require that the federal government balance the budget

and most economists would agree that this is a good thing. After all, when the economy is

in a recession, tax revenues are going to be low and deficits are likely to occur. Balancing

the budget requires a combination of higher taxes and less spending, which only exacerbates

the recession! Likewise, during a period of economic expansion, tax revenues are high and

surpluses occur. Balancing the budget requires lower taxes or higher levels of spending to

eliminate the surplus, which continues the expansion and risks higher inflation rates.

On the other hand, many state and local governments are required by law to balance

their budgets. During recessions, tax revenue collected by these levels of government fall

and elected officials are required to increase taxes and make difficult decisions on which

state and local programs need to be cut.

So while the federal government is cutting taxes to increase your disposable income and

spur economic growth, your state and local governments are increasing your taxes to make

up for the budgetary shortfalls caused by the very recession the federal government is trying

to fix. Argh! In my state of Indiana, since 2001 citizens have seen a 1 percent increase in

the sales tax, increases in property taxes, and, in the history of my county, the first ever

Supply $

Demand $

Demand $

Quantity of $

Euro price

of a $

E 0

E 1

Figure 10.7

TIP

“Don’t try to
figure it out
in your head.
Draw the
graphs and read
your answers
from them.”
—Nate,
AP Student