Transcript Unit 5: Monetary and Fiscal Policy Combined

Unit 5: Monetary and Fiscal
Policy Combined
Goals of Economic Policy
• Stabilizing the economy
• Keeping employment high
• Price level stable
– If aggregate demand is too low, there will be
unemployment
– If aggregate demand is too high, there will be
inflation
• Try to think of TWO fiscal policy tools
Could you remember any???
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Government spending
Taxes
Income tax brackets
Unemployment compensation
Stock and bond returns
Fiscal policy is one of the two
demand management policies
available to policy makers.
• Government expenditures (i.e.
government spending)
• Level and type of taxes
• Both are considered discretionary fiscal
policy tools
Basically…..
• This is how the government can increase
aggregate demand in an effort to increase
our productivity (or real GDP)
• Also a way to increase employment during
a recession
Government Spending:
• Affects the economy directly by increasing the
demand for goods and services
• When the government increases spending, it
initiates a multiplier process that results in a
greater increase in total spending than the initial
increase
• Will increase aggregate demand (AD), shifting it
to the right
• In the short run, this will result in an increase in
real GDP and the price level
– Considered expansionary if the change increases AD
and/or real GDP
• Examples: $700 billion Wall Street buy out
Changes in Taxes:
• Does not directly change real GDP
• Changes in taxes affect the disposable
income of households or businesses
• The changes are felt through consumption
spending and investment spending
• An increase in taxes will decrease
disposable income
• A decrease in disposable income will
decrease consumption (but by less than
the increase in taxes) ---- some of the
additional cost of taxes will come out of
their savings
Automatic Stabilizers
• There are many tools embedded in the
economy that respond to the different
phases of the business cycle: automatic
stabilizers
• Called automatic b/c they adjust without
an action by Congress or the President
• They limit the increase in real GDP during
expansions and reduce the decrease in
real GDP during recessions
Income Tax System
• As your nominal income increases, you
move into a higher tax bracket and pay
more taxes
• This limits the increase in disposable
income and consumption
• Vice-versa, if you take a pay cut you move
to a lower bracket and therefore have
lower taxes
Unemployment Compensation
• As the economy slows and unemployment
increases, the income of the unemployed
does not fall to zero
• Unemployment comp. provides a base
level of income and the negative impact on
real GDP is lessened
Stock and Bond Returns
• Many corporations establish the dividends
they pay on shares of stock and maintain
this payout for several years
• Thus, dividends do not follow swings of
the business cycle
• Bond payments maintain their value
throughout their “lifetime”
Three Monetary Tools
• 1. Open Market Operations: buying and
selling bonds
• 2. Reserve Requirements: changing the
reserve ratio at banks
• 3. The discount rate
How much time do these policies
take to get initiated???
• Inside lag: the time it takes for data to be
collected, policy makers to recognize that
policy action is necessary, the decision
about which policy should be taken and
the implementation of the policy
• In Washington that could take FOREVER!
How much time does it take these
policies to actually impact the
economy?
• Outside lag: the time it takes the economy
to respond to the new policy
*** it takes a varying amount of time for the
different policies***