>> We think that given enough
time for prices and wages

to adjust, output gaps will
eventually correct themselves.

But many economists
say why wait?

One way for policymakers
to intervene in the economy

and push output back to
potential is with fiscal policy.

There are basically
two ways for government

to enact fiscal policy.

Through changes in government
spending and changes in taxes.

Suppose the economy has fallen
into a recessionary gap.

The government can implement
expansionary fiscal policy

by increasing government
purchases or cutting taxes.

Either of these actions
will boost aggregate demand,

shifting it out to the right.

The government has
done this several times

in response to recessions.

In the early 1980s,
President Reagan cut taxes

in increased defense spending.

This helped power the economy
out of the early '80s recession.

In 2009 in response
to the deep recession

that followed the
financial crisis,

President Obama also
increased spending

and cut payroll taxes
for workers.

As a result, employers were back

to hiring workers less
than a year later.

Likewise, suppose the economy
enters an inflationary gap.

The government can implement
contractionary fiscal policy

by cutting government
purchases or raising taxes.

Either of these actions will
reduce aggregate demand,

shifting it to the left.

It's actually pretty rare for
politicians to cut spending

or raise taxes in an effort
to slow down the economy.

However, concerns
about the deficit

over the past few years have
led Congress to cut some forms

of spending through measures

like sequestration,
and fiscal cliffs.

And as a result the economy
has grown more slowly

than it would have
without these measures.

So fiscal policy is how the
government changes taxes

or spending to boost or
reign in the economy.

Expansionary fiscal
policy cuts taxes

or raises spending
to increase output.

While contractionary
fiscal policy raises taxes

or cuts spending to
hold the economy back.