Transcript Chapter 15 - Leuzinger High School

Chapter 15
Fiscal Policy,Deficit, and Debt
Potential output
• Is the economy’s maximum sustainable
output in the long run, given the supply of
resources, the state of technology, and the
rules of the game that nurture production
and exchange.
• Potential output referred to the fullemployment output.
continued
• GDP of $12 trillion potential output is real
GDP of $12 trillion.
• In theory, fiscal policy can be used to
ensure the economy achieves its potential,
w/ full employment and price stability.
• Natural rate of unemployment- the
unemployment rate when the economy is
producing its potential level of output.
USA
• Natural rate of unemployment are in the range of 4 to 5
% of the labor force.
• 2008 rate is 7.2%
• Contractionary gap- the amount by which short-run
output falls below the economy’s potential output.
• If output is below the economy’s potential, policy makers
often decide to reduce taxes or increase government
spending. (idea is to stimulate aggregate demand is a
way of increasing output to its potential.)
Expansionary gap
• The amount by which actual output in the
short run exceeds the economy’s potential
output.
• Production creates inflationary pressure in
the economy.
• Production exceeding the economy’s
potential is not sustainable in the long run.
Normal production capacity
• Studying. Same pace through out the year.
Nearing exams students study more.
• Producers, too can exceed their normal capacity
in the short run to push output beyond the
economy’s potential.
• Long run , the economy does not exceed its
potential, just as you don’ t boost your study
effort permanently.
• Output in the long run gravitates back to the
economy’s potential.
Classical economists.
• Prior to great depression, public policy was
shaped by the vies of classical economists.
• They advocated laissez faire.
• Laissez-faire, the belief that free markets w/o
govn’t intervention were the best way to achieve
the economy’s potential output.
• Didn’t deny depressions or high unemployment.
Due to wars, tax increases, poor growing
season,
Classical economists
• Believed, that natural forces such as
declining prices, wages, and interest
rates, would end any recession in a
relatively short time by encouraging
people and businesses to spend more.
• Classical economists argued.
Annually balanced budget
• Matching annual spending w/ annual
revenue, except during war years;
approach to the federal budget prior to the
Great Depression.
• Great Depression 25% unemployed.
• John Maynard Keynes (Cambridge
University 1936).
Multplier effect
• Any change in fiscal policy affects
aggregate demand by more than the
original change in spending or taxing
Chapter 15.2
• Discretionary fiscal policy- Congressional
changes in spending or taxing to promote
macroeconomics goals.
• Automatic stabilizers- Government
spending and taxing programs that year
after year automatically reduce
fluctuations in disposable income, and
thus in consumption, over the business
cycle.
Problems w/ Discretionary Fiscal
Policy
• Stagflation
• Calculating the natural rate of
unemployment. Not easy.
• (4 to 5% unemployment rate)
• The Problem of Lags
• Recognition lag- the time needed to
identify a macroeconomic problem
continued
• Decision making lag- the time needed to
decide what to do once the problem has
been identified.
• Implementation lag- the time needed to
execute a change in policy.
• Effectiveness lag- the time needed to
change in policy to affect the economy.
Chapter 15.3
• Federal Deficits and Federal Debt
• 2008-2009 1.3 trillion dollars debt
• Federal reserve has printed only $900
billion.
• More than half the money is unaccounted.
Budget Deficit
• Measures the amount by which total federal spending
exceeds total federal revenues.
• Why is the budget usually a deficit?
• Congress is not required to balance the budget.
Spending wins people’s votes and taxing loses people’s
votes.
• The Surplus of 1998-2001. Bill Clinton and his
administration balance the budget. George W. Bush’s
administration spent 1.3 trillion on 2 wars and natural
disasters such as Katrina, and other natural disasters
through out the nation.
• Federal Reserve kept interest rates low to prevent
inflation. Housing boom, deregulation in the loans, and
predator lenders. Hike in interest rates.
Deficit and Interest rate
• Crowding in- government spending
stimulates private investment in an
otherwise stagnant economy.
• Crowding out- private investment falls
when higher government deficits drive up
interest rates.
Chapter 16 sec. 1Money and
Banking
• Barter-A system of exchange in which products
are traded directly for other products.
• Money- functions medium of exchange, a unit of
account, and a store of value.
• Medium of exchange- Anything generally
accepted by all parties in payment for goods or
services.
• Commodity money- Anything that serves both as
money and as a commodity, such as gold.
Unit of account
• A standard on which to base prices.
• Shoes, made out of leather (hide), or pots may
be measured by bushels of corn.
• Corn becomes the common denominator, a
yardstick, for measuring the value of all goods
and services.
• Buyers and sellers could price everything using
a common measure, such as corn.
Store of value- Anything that retains its purchasing
power over time.
Commodity Money
• Limitations of Commodity Money.
• The ideal money is durable, portable,
divisible, of uniform quality, has a low
opportunity cost, does not fluctuate wildly
in value, and is in limited supply.
continued
• Durable- last long, unlike corn that is
perishable (rotten).
• Portable- carry around easily.
• Divisible-$1.00, $2.00, $5.00. $10.00,
$20.00, $50.00, $100
• Coins pennies, nickels, dimes, quarter, fifty
cents, dollar coins.
• Uniform Quality- similar embossed
images.
continued
• Low Opportunity Cost-Commodity money
usually tied up as valuable resources, so it
has high opportunity cost compared with
paper money.
• Ex. Corn that is used for money cannot at
the same time be used as food. The ideal
money has a low opportunity cost.
continued
• Supply or Demand Must Not Fluctuate Erratically
• Supply and Demand of commodity money
determine the prices of all other goods.
• A record harvest would increase the supply of
corn. An increase in the popularity of corn as
food would increase the demand of corn. Each
would alter the price level measured in corn.
• Erratic fluctuations in the supply or demand for
corn limit its usefulness as money, particularly as
a unit of account and as a store of value.
continued
• Limited Supply- value of money depends
on its limited supply, anything that can be
gathered or produced easily would not
serve well as commodity money.
• Ideal money should be in limited supply
Coins
• Bushel of corn, rock salt cut into block
used as money.
• Silver & Gold were used as money.
• Used cheaper metals, quantity & quality
was solved by coining silver & gold.
• Coinage determined both the amount &
quality of the metal.
• Coins-durable, easy to carry, precious
metals
Coin
• Table on which money was
counted during this era came
to be called the counter.
• The power to coin was vested
in the feudal lord or seignior.
• If the exchange value of the
coin exceeds the cost of
making it, minting coins
became a source of revenue
to the seignior.
• Token money is money whose
exchange value exceeds the
cost of production.
Ch. 16 s. 2 Origins of Banking and
the Federal Reserve System
• Gold coins on deposit w/ a
goldsmith.
• Pay & deposit w/ goldsmith.
• Bank Checks
• Checks-A written order
instructing the bank to pay
someone from an amount
deposited.
• Bank Loans-The goldsmith
could extend a loan by
creating an account against
which the borrower could write
checks. In this way goldsmiths,
or banks, were able to create a
medium of exchange- “create
money”.
Goldsmith shop
Check by Wells, Fargo & Co 1868
Bank loan
• This money, based
only on an entry in the
banks ledger, was
accepted because of
the public’s
confidence that the
bank would honor
these checks.
Fractional reserve banking system
• Only a portion of bank deposits is backed by
reserve.
• In this system, the goldsmith’s reserves
amounted to just a fraction of the claims by
depositors.
• The reserve ratio measures bank reserves as a
share of deposits. Ex. If the goldsmith had gold
reserve valued at $40,000 but deposits totaling
$100,000, the reserve ration would be 40%.
Bank Notes
• Bank notes were pieces of paper promising the
bearer a specific amount of gold or silver when
the notes were redeemed at the issuing bank.
• Checks could be redeemed for gold only if
endorsed by the payee. Bank notes, however,
could be redeemed for gold by anyone who
presented them to issuing bank.
• Paper money is portable.
• Representative money-Bank notes that
exchange for a specific commodity, such as
gold.
Fiat Money
• Fiat money- Money not
redeemable for anything
of intrinsic value;
declared money by
government decree.
• Ex. Currency issued by
the U.S. government &
nearly all other
governments throughout
world today is fiat money.
Fiat Money
• Requires only some paper and a printing
press.
Depository Institutions
• Accept deposits from the public and make
loans from these deposits.
• Commercial Banks: Depository institutions
that make loans primarily to businesses
than to households.
• Until 1980 commerical banks were the
only depository institutions that offered
demand deposits, or checking accounts.
Commercial banks
• Demand deposits are so named because
a depositor with such an account can write
a check demanding those deposits.
Thrifts
• Thrift institutions, or thrifts, include savings and
loan associations, mutual savings banks, and
credit unions.
• Historically, savings & loans associations and
mutual savings banks specialized in making
home mortgage loans.
• Credit unions, which tend to be small, account
for most thrifts. Extend loans to “members” to
finance homes or other consumer purchases.
Dual Banking System
• Before 1863, banks were chartered called
state banks.
• Goldsmiths made different notes.
• Thousand’s of different notes circulated at
the same time, & nearly all redeemable
for gold.
• The National Banking Act of 1863 & other
acts created news system of Chartered
banks called National Banks.
Federal Reserve System (Fed)
• Established in 1913 as the central bank and
monetary authority of the United States.
• Other industrialized countries established central
banks; Bundesbank in Germany, the Bank of
Japan, and the Bank of England.
• America’s suspicion of monopolies initially led to
the establishment of 12 separate banks in the
Federal Reserve districts around the country.
Federal Reserve System
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Named after the cities in which they were located.
Federal Reserve Banks of
Boston
New York
Chicago
San Francisco
Philadelphia
Richmond
Cleveland
St. Louis
Kansas City
Minneapolis
Dallas
The Twelve Federal Reserve
Districts (www.federalreserve.gov)
Federal Reserve System
• Federal Reserve Board of Governors “to
exercise general supervision” over the
Federal Reserve System to ensure
sufficient money and credit in the banking
system. The power to issue banks notes
was taken away from national banks and
turned over the Federal Reserve.
Take a look at paper currency and
you will read “Federal Reserve
Note” across the top
• These notes actually are printed by the
U.S. Bureau of Printing and Engraving,
which is part of the U.S. Treasury.
• The Treasury prints the notes but the Fed
has responsibility for putting them into
circulation.
Federal Reserve
• It does not deal w/ the public directly.
• Bankers’ bank.
• Banks hold deposits for member banks,
just as commercial banks and thrifts hold
deposits for the public.
• The name “Reserve Banks” comes from
the responsibility to hold member- bank
reserves on deposits.
Reserves
• Consist of cash that banks have on hand
in their vaults or on deposit with Reserve
banks.
• Bank can clear a check written by a
depositor at one bank, such as Bank of
America and deposited in another bank,
such as your bank.
Reserves
• Reserve Banks also extend loans to
member banks.
• The interest rate charged for these loans
is called the discount rate.
• By making loans to banks, the fed can
increase reserves in the banking system.
Directing Monetary Policy
• The Federal Reserve’s Board of
Governors is responsible for setting and
carrying out the nation’s monetary policy.
• Monetary Policy is the regulation of the
economy’s money supply and interest
rates to promote macroeconomic
objectives such as full employment, price
stability, and economic growth.
Board of Governors
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Members
Since 1913
Ben S. Bernanke, Chairman | Donald L. Kohn, Vice Chairman | Kevin M.
Warsh | Elizabeth A. Duke | Daniel K. Tarullo
The seven members of the Board of Governors of the Federal Reserve
System are nominated by the President and confirmed by the Senate. A full
term is fourteen years. One term begins every two years, on February 1 of
even-numbered years. A member who serves a full term may not be
reappointed. A member who completes an unexpired portion of a term may
be reappointed. All terms end on their statutory date regardless of the date
on which the member is sworn into office.
The Chairman and the Vice Chairman of the Board are named by the
President from among the members and are confirmed by the Senate. They
serve a term of four years. A member's term on the Board is not affected by
his or her status as Chairman or Vice Chairman.
Board Membership
• Relatively stable b/c a new U.S. President
can be sure of appointing or reappointing
only two members in a presidential term.
• The Board structure is designed to
insulate monetary authorities from
pressure by elected officials.
Federal Open Market Committee
• Originally , the power of the Federal
Reserve System was vested in each of the
12 Reserve Banks.
• (FOMC) to consolidate decisions
regarding the most important tool of
monetary policy-open-market operation.
Open-Market operations
• Consist of buying or selling U.S.
government securities to influence the
money supply and interest rates in the
economy.
President appoints, Senate confirms
Federal Open Market Communittee
Federal Advisory Committee
Board of Governors
12 Federal Reserve Banks
National banking system:
Commercial banks, Savings, & loan associations, Mutual savings banks, Credit Union