Transcript fiscal & monetary policy

Chapters 15 & 16
• TWO TOOLS:
• Fiscal & Monetary Policy
• What’s the difference?
• Fiscal Policy
• The Budget – taxing and spending
• The use of government spending
and revenue collection to influence
the economy
• Fed. government regulating taxes &
expenditures – Public control
• Monetary Policy
• Money Supply
• Private control since Fed controls the
amount of $ in circulation
• The federal government makes
key fiscal policy decisions each
year when it establishes the
federal budget.
• Taxing & Spending &
Borrowing
• By Congress & P (although
Constitution gives Congress
the most economic power)
• The federal government
prepares a new budget for
every fiscal year, which goes
from Oct. 1 to Sept. 30.
• Who takes the first step in
the budget process?
1
2
3
4
• Expand or slow economic growth
• Achieve full employment
• Maintain price stability
• Fiscal policy is limited because it is difficult to know
which way the economy is heading and which type
of fiscal policy will be the most helpful.
• Expansionary policy: used to encourage economic
growth, often through increased spending or tax cuts
• Contractionary policy: used to reduce economic
growth, often through decreased spending or higher
taxes
• Governments use expansionary fiscal policy to
encourage growth, either to prevent a recession
or to move the economy out of a recession.
• This involves
either increasing
government
spending or cutting
taxes, or both.
• Contractionary fiscal policy tries to decrease
aggregate demand, and in doing so, reduce the
growth of economic output.
• Why would the government deliberately slow down
economic output?
• Because fast growing demand can exceed supply.
• If producers cannot expand production to keep up
with increasing demand, they will raise prices, which
causes inflation.
• Fiscal policy aimed at slowing the growth of
total output generally involves decreasing
government spending or raising taxes or
both.
•How does lower
government
spending affect
equilibrium?
• FISCAL POLICY CAN BE DIFFICULT TO PRACTICE.
• Cumbersome, difficult task to increase or decrease the amount
of federal spending.
• Entitlement programs make up the bulk of the budget.
• CHANGES TAKE TIME!
• By the time the effects are felt, the economy might be moving in
a different direction.
• Government officials want to get re-elected!
• Makes it hard to always do what’s best for the economy
• CLASSICAL ECONOMICS.
• Adam Smith
• Free markets regulate
themselves
• BUT, this idea challenged by the
Great Depression since the
economy was unable to
regulate itself, which led to high
unemployment and massive
bank failures.
• Major problem is that this idea
doesn’t address how long it
would take for the market to
return to equilibrium.
• British economist John Maynard Keynes - a
new theory to explain the Depression.
• Keynes argued that the Depression was
continuing because neither consumers nor
businesses had an incentive to spend enough to
increase production.
• The only way to end the Depression, according to
Keynes, would be to find a way to boost
demand.
• Government should be responsible for
spending more money in order to boost
demand.
• The government could make up for the drop
in private spending by buying goods and
services on its own.
• Keynes argued that fiscal policy can be used to fight
periods of recession:
• If consumer spending drops, government should respond by
dropping its own spending until consumer spending goes back
up.
• OR it can cut taxes so that spending and investment by
consumers and businesses increases.
• Keynes also argued that the government can reduce
inflation either by increasing taxes or by reducing its
own spending.
• Based on the idea that the supply of goods drives the economy.
• Supply-side economists believe that taxes have a strong
negative impact on economic output.
• Argument is that a tax cut increases total employment so much
that the government actually collects more in taxes at the new,
lower rate.
• Fiscal Policy History:
• In the 1940s – spending up or down?
• Did Keynesian economics work?
• Economy’s condition between 1945 and 1960?
• JFK & LBJ?
• Ronald Reagan – 1980s?
• Liberal theory – KEYNESIAN
• John Maynard Keynes
• Government as active participant
• spend $ to stimulate demand
& help a lagging economy
• Deficit spending not a problem
• Other followers of Keynesian
theory?
• Conservative theory – SUPPLY-SIDE
ECONOMICS
• Decrease government’s involvement
• Big government taxes too heavily, spends
too freely, regulates too tightly, and thereby
actually curbs economic growth
• Stimulate supply of goods so cost of goods
declines
• Greater production accomplished through tax
cuts & spending cuts on social programs
• Budget surplus: a situation in which budget revenues
exceed expenditures
• Budget deficit: a situation in which budget
expenditures exceed revenues
• National debt: the total amount of money the federal
government owes to bondholders
• Effects of budget deficits on the national debt?
• A budget deficit leads to an increase in the amount that the
government has to borrow.
• As the government borrows more money, the national debt
increases, which means there are fewer funds available for
investing.
• The federal budget basically consists of
two parts:
– Revenue—taxes
– Expenditures—spending programs
• When revenues and expenditures are = the budget is
balanced.
• How often do you think the budget is actually balanced?
– Almost never balanced; it either runs a surplus or a deficit.
• How does the federal government usually respond to a budget
deficit?
– By borrowing money.
– From who?
– Why doesn’t it just create new money?
• The deficit is the amount of money the government borrows for
one fiscal year while the debt is the sum of all government
borrowing before that time minus the borrowing that had been
repaid.
• So… every year there is a budget deficit and the federal
government borrows money to cover it, the national debt
increases.
• Current National Debt?
• #1 - Reduces the funds available for businesses to invest
because in order to sell its bonds the government must offer a
high interest rate.
• So… individuals and businesses buy these bonds instead of
investing in private business - known as the crowding-out
effect.
• #2 - Government must pay
interest to bondholders.
• Over time, these interest payments
have become very large
• The government must pay out this
interest and cannot spend this money
on other programs such as defense,
healthcare, or infrastructure.
• #3 - The debt may be foreignowned
• Causes a fear that foreign countries
may use their bondholdings as a tool
to extract favors from the United
States.
• A deficit causes federal government
to borrow $ (bonds)
• Interest paid on bonds is now part of
federal budget
• Economic downturns, external shocks, Hurricane Sandy,
can lead to more borrowing
• More borrowing makes interest payments a larger
piece of federal budget
• The more interest that has to be paid, the more the
government has to borrow