Transcript L8 Monetary and Fiscal, no ISLM

Monetary and Fiscal Policy
Current Events
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Millions of Poor Are Left Uncovered by Health Law
A sweeping national effort to extend health coverage to
millions of Americans will leave out two-thirds of the poor
blacks and single mothers and more than half of the lowwage workers who do not have insurance, the very kinds
of people that the program was intended to help,
according to an analysis of census data by The New
York Times.
Because they live in states largely controlled by
Republicans that have declined to participate in a vast
expansion of Medicaid, the medical insurance program
for the poor, they are among the eight million Americans
who are impoverished, uninsured and ineligible for help.
The federal government will pay for the expansion
through 2016 and no less than 90 percent of costs in
later years.
http://www.nytimes.com/interactive/2013/10/02/us/unins
ured-americans-map.html?ref=health
Poverty Should Have Risen By CASEY B.
MULLIGAN
Current Events
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On Day 3 of Shutdown, Neither Side
Budging in Budget Standoff
Obama Sets Conditions for Talks: Pass
Funding and Raise Debt Ceiling
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Opening Up the Fed (NYT 2/12) S. Johnson
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The Federal Reserve has great power in modern
American society, including the ability to move the
economy and, at least indirectly, to create or destroy
fortunes. Its powers operate in two ways: through
control over monetary policy, meaning interest rates
and credit conditions more broadly, and through its
influence over how the financial system is regulated
generally and how specific large banks are treated.
…during the 1980s the Fed’s board held 20 to 30
public meetings a year, but these dwindled during
the Greenspan years to fewer than five a year in the
2000s and “only two public meetings since July
2010.”
…meetings with opponents of reform outnumber
meetings with supporters of reform about 10 to 1
What is ISLM economics?
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Discussed real sector of economy:
production and income
Discussed monetary sector
What policy tools do we have to affect
these?
Rough model. “Economics is a two-digit
science”
Idea is that economy is always moving
towards equilibrium
Equilibrium system or complex
system with leverage points?
Chapter 7: Efficiency and Exchange
Slide 6
Macroequilibrium in Real Sector
Conventional Goals of Monetary and
Fiscal Policy
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Continual economic growth
Stable prices
‘Full’ employment
Ecological Economic Goals?
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Ecological sustainability
Just distribution
Efficiency
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Max QOL/sustainable throughput, NOT
monetary value of goods and services
Threats to growth
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Bubbles and Busts
Speculative investment
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Lack of investment
Which comes first?
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Financial instability hypothesis
Propensity to Save
What has happened to US propensity to save?
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In last 50 years? In last 4 years?
Paradox of thrift
Biophysical limits
Social and psychological limits
Monetary Policy
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Based on supply and demand for money
Price of money = interest
Increase supply, price goes down, and vice
versa
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Decrease interest, and more investments
become lucrative
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Who controls money supply?
Creates jobs, stimulates consumption
But what do people invest in?
Decrease interest, and people buy more on
credit, save less
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Creates demand for projects, stimulates
investment
Drives speculation
Monetary Policy
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Only affects market goods directly
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Typically a trade-off between scale and
distribution
Poor at dealing with public goods, including
ecosystem services
Changing reserve requirements
Blunt instrument
Who’s in charge of MP?
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“The Federal Reserve, through its power to
raise and lower interest rates, exercises
more influence over economic growth and
the level of employment than any other
government entity. That unusual role dates
from the 1970s, when the executive branch
and Congress pulled back from the use of
fiscal tools — vast New Deal spending and
targeted tax cuts — as a means of
regulating prosperity.”
NYT 2009
Is this true? Real world
Fiscal conservatives?
Who Controls the Fed?
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The governors appointed by the president
for 14 years, approved by Congress
Chair appointed for 4 years
Regional bank presidents “selected by
leaders of their communities, particularly
bankers.” (NYT)
Monetary Policy:
4 tools Fed can use:
Reserve requirements (within bounds set by
congress)
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Allows private banks to create more or less money
Interest rates (discount window)
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Rate at which Fed loans money to banks
Open market operations: buying and selling
government securities (bonds)
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Changes money supply.
Goal typically is to increase or decrease overnight interest
rates for banks loaning to one another (Fed funds rate)
Quantitative easing
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Buying governments bonds from gov’t
Buying toxic assets from private sector, corporate bonds
Could buy municipal bonds
What is the real goal of the Fed?
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Officially to target unemployment and
inflation
“Their main thrust has been to limit inflation,
even at the risk of a recession”
NYT 2005, calling Bernanke a safe choice:
“The lessons of the Depression sometimes
seem to hover behind much of his thinking.
Shortly after becoming a Fed governor in 2002,
for example, Mr. Bernanke argued forcefully for
tough action to head off a possible epidemic of
deflation, or downward spiraling prices.”
Why does Fed Target Inflation?
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“In settling on Mr. Bernanke, President
Bush ... chose a candidate who would
satisfy others -- investors on Wall Street,
lawmakers in Congress -- more than himself
or his Republican base.”
''They needed somebody that everybody,
including the financial markets, would react
positively to.''
“But Mr. Bernanke had what many
outsiders wanted: a world-class reputation
among economists; credibility on Wall
Street”
Why does Fed Target Inflation?
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NYT: To Senators, Bernanke Defends the
Fed’s Dual Objectives
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Senate Republicans on Tuesday, like their
colleagues in the House last week, expressed
concern that the Fed effectively was declaring
that it would prioritize job growth over inflation.
“I want to disabuse any notion that there is a
priority for maximum employment,” Mr.
Bernanke responded.
Current Events
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Latest ‘Nobel’ laureates in econ
Debt default
Fighting Inflation
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Monetary policy
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Raise interest rates: bad for debtors, good for
creditors, bad for farming, construction
Decrease money supply
Blunt instrument
Either one can increase unemployment,
reduce wages
Feds 2 goals are at odds
Fighting Deflation
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Bernanke’s remedies
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Buying treasury securities with longer maturities
Buy up private debt, e.g. corporate bonds
“In effect, the Federal Reserve would be printing
more money and injecting it into the economy —
a strategy of “quantitative easing,” in Fed
jargon.”
Limits to Monetary Policy
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Liquidity trap
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When demand is inadequate, firms have excess
capacity, increasing money supply (reducing r)
has no impact on investments.
'Pushing on a string’
Seems to be our current status
Current Monetary Policy
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Discount window from 5.75% August 2007
to ~0% today; Fed funds rate shows similar
plunge
“keep short-term interest rates near zero
until late 2014”
Fiscal Policy
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Taxation
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Government expenditure
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Reduces demand, contracts economy, drives
down interest rates
Stimulates investment, expands economy
Drives up interest rates if competing with private
sector
Crowding out
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When economy is at full capacity, government
expenditure might simply displace private sector
expenditure
This was dominant belief until recession
Allows macroallocation between market and
non-market resources
3 Ways for Government to Spend
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Tax and spend
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Borrow and spend
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Spending more than counteracts equal tax
Surplus = taxes > expenditures
Greater short term impact than tax and spend
Deficit = expenditures > taxes
Borrowing now = taxes in future
Print money and spend
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Does not increase interest rates
Threat of inflation
We could increase reserve requirements,
give government more control
Current Fiscal Policy
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Europe
US
Stimulus? Reagan vs. Obama
Reagan
Up 3.1%
Gov’t
employment
Gov’t purchases Up 11.6%
goods and
services
Total gov’t
Up >10%
spending,
including
transfers
Obama
Down 2.7%
Down 2.6%
Up 2.6%
Or Austerity?
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Severe austerity in Europe
“Republicans swept to a majority in the
House on an antideficit platform”
Goal now is deficit reduction
Quiz
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What impact should a monetary expansion
have on interest rates and economic
growth?
What impact should an increase in the
savings rate have on economic growth?
What impact should a tax increase have on
economic growth?
What impact should an increase in
government spending have on economic
growth?
Impact of Policies on Scale,
Distribution and Allocation
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What should our goals be?
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Sustainable Scale
Just Distribution
Efficient allocation
Stability
How do we reduce consumption without
increasing unemployment, while making poor
better off?
What is appropriate balance between market
goods and public goods?
Integrating Monetary and Fiscal
Policy
From
To
Fractional reserve banking
100% reserve requirements
(window of opportunity)
Private sector seigniorage
Public sector seigniorage
Growing money supply for
growing economy
Constant money supply? for
steady state economy
Pro-cyclical
Countercyclical
New money spent on
market goods
New money spent on public
goods or loaned for
essential market goods
Taxing income and labor
Taxing throughput and
unearned income
Fiscal Policy to Regulate Gov’t
Created Money Supply
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Spend and tax
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Lend and repay
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Taxes destroy any money spent into existence.
Counter-cyclical expenditures must be accompanied by
future tax increases.
Tax things we don’t want
Government can lend money interest free for
investment in public goods or critically important market
goods
Repayment destroys money
Money can be lent to state and municipal governments,
or used to purchase interest free bonds (monetizing
state and local debt)
Time deposits in local banks
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The government can deposit money in local banks for
fixed periods of time, and the banks can then loan this
money to customers. Withdrawal of the loan and
payment of interest on the government portion of the
loan both destroy the money created.
Taxes for a Sustainable and Just
Economy
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Tax (or charge for) bads, not goods
Tax what we take, not what we make
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Capturing rent (unearned income)
What are current tax rates on unearned income?
Taxation as a form of redistribution
Taxes to back money supply
Fiscal Policy
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Taxes
Can be targeted:
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'tax bads, not goods’
'tax what we take, not what we make’
Progressive taxes
Reduces overall consumption
Stabilizes economy
Can have important impact on scale
WWII 96% marginal tax rate
Fiscal Policy
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Subsidies
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Research and development
Activities that provide positive externalities:
'subsidize goods, not bads'
Fiscal Policy
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Government expenditures
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Can be targeted: welfare for corporations or for
the poor?
Public goods or private goods? What offers
highest marginal benefits?
Investments in human made vs. natural K
Crowding out in a full world
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At full employment, gov’t expenditures on public
goods displace private expenditures