Transcript monetary and fiscal policies - Marlboro Central School District

MONETARY AND FISCAL POLICIES
Barbulean
STAGES OF INFLATION
• 1. CREEPING INFLATION
(0%-3%)
• 2. WALKING INFLATION
( 3% - 7%)
• 3. RUNNING INFLATION
(10% - 20 %)
• 4. HYPER INFLATION
( 20% and abv)
TYPES OF INFLATION
1. Demand Pull Inflation
2. Cost Push Inflation
Causes of Inflation
• 1. Demand pull Inflation
Causes for Increase in Demand :a)
b)
c)
d)
e)
f)
Increase in Money Supply
Increase in Black Marketing
Increase in Hoarding
Repayment of Past Internal Debt
Increase in Exports
Deficit Financing
Cont……….
g)Increase in Income
h)Demonstration Effect
i)Increase in Black money
j) Increase in Credit facilities
Cont….
• 2) Cost Push Inflation
Causes for Increase in Cost :a) Increase in cost of raw materials
b) Shortage of Supplies
c) Natural calamities
d) Industrial Disputes
e) Increase in Exports
f) Increase in Wages
g) Increase in Transportation Cost
h) Huge Expenditure on Advertisement
Effects of Inflation
• Inflation can have positive and negative effects on
an economy. Negative effects of inflation include
loss in stability in the real value of money and
other monetary items over time; uncertainty
about future inflation may discourage investment
and saving, and high inflation may lead to
shortages of goods if consumers begin hoarding
out of concern that prices will increase in the
future. Positive effects include a mitigation of
economic recessions, and debt relief by reducing
the real level of debt.
What is the Monetary Policy?
• The Monetary and Credit Policy is the policy
statement, traditionally announced twice a year,
through which the Federal Reserve Bank seeks to
ensure price stability for the economy.
These factors include - money supply, interest
rates and the inflation. In banking and economic
terms money supply is referred to as M3 - which
indicates the level (stock) of legal currency in the
economy.
Besides, the Fedalso announces norms for the
banking and financial sector and the institutions
which are governed by it.
How is the Monetary Policy different
from the Fiscal Policy?
• The Monetary Policy regulates the supply of money and the cost
and availability of credit in the economy. It deals with both the
lending and borrowing rates of interest for commercial banks.
• The Monetary Policy aims to maintain price stability, full
employment and economic growth.
• The Monetary Policy is different from Fiscal Policy as the former
brings about a change in the economy by changing money supply
and interest rate, whereas fiscal policy is a broader tool with the
government.
• The Fiscal Policy can be used to overcome recession and control
inflation. It may be defined as a deliberate change in government
revenue and expenditure to influence the level of national output
and prices.
What are the objectives of the
Monetary Policy?
• The objectives are to maintain price stability and
ensure adequate flow of credit to the productive
sectors of the economy.
Stability for the national currency (after looking
at prevailing economic conditions), growth in
employment and income are also looked into.
The monetary policy affects the real sector
through long and variable periods while the
financial markets are also impacted through
short-term implications.
Fed’s Tools of Monetary
Control
The Fed has 3 “tools” in its monetary toolbox:
1) Changing the Reserve Requirement
2) Open-Market Operations (buying & selling
government securities performed by the Federal OpenMarket Committee)
3) Changing the Discount Rate
Monetary Policy Tools
CONTROLLING THE MONEY SUPPLY THROUGH BANKS
THE RESERVE REQUIREMENT
•
•
Reserves are deposits that banks have
received but have not loaned out.
In the U.S. we have a fractional reserve
banking system:
–
banks hold a fraction of the money
deposited as reserves and lend out the
rest.
Monetary Policy Tools
CONTROLLING THE MONEY SUPPLY THROUGH BANKS
THE RESERVE REQUIREMENT
The money supply in America is affected by
the amount deposited in banks and the
amount that banks loan out.
 The fraction of total deposits that a bank has to
keep as reserves is called the reserve
requirement ratio.
 Put another way, the reserve requirement is the
amount (10%) of a bank’s total reserves that may
not be loaned out.
• Open Market Operations:
the buying and selling of U.S. securities
(national debt in the form of bonds) by the Fed.
– This is the primary tool used by the Fed.
– Fed buys bonds – the money supply expands:
• bond buyers acquire money
• bank reserves increase, placing banks
in a position to expand the money supply through the
extension of additional loans.
– Fed sells bonds – the money supply contracts:
• bond buyers give up money for securities
• bank reserves decline, causing them to extend fewer
loans.
MS*
MS1
Nominal
Interest
The Federal Reserve
Controls the Money
Supply, which determines the
Nominal Interest Rate in the
Short-Term Money Markets
I*
Rate
I1
DM*
Qm*
Money Supply
Qm1
Note: Qm*
represents M1
Money Supply
Buying bonds (securities), lowering the Reserve Requirement or lowering the
Discount Rate, will put more money into the banking system. Supply of funds
available in the banking system will INCREASE!!
MS1
MS*
Nominal
Interest
I1
Rate
The Federal Reserve
Controls the Money
Supply, which
determines
The Interest Rate
I*
DM*
Qm1
Qm*
Money Supply
Selling bonds (securities), Raising the Reserve Requirement or
Raising the Discount Rate, will take money out of the banking
system. Supply of funds available in the banking system will
DECREASE!!
Monetary Policy Tools
CONTROLLING MONEY SUPPLY THROUGH THE INTEREST RATE
THE DISCOUNT RATE (Federal Funds Rate)
•
The Discount Rate is the interest rate the
Fed charges banks for loans.
Increasing the discount rate decreases
the money supply.
Decreasing the discount rate increases
the money supply.
• Discount Rate:
the interest rate the Fed charges banking
institutions for borrowed funds.
– An increase in the discount rate decreases the
money supply (restrictive) because it discourages
banks from borrowing from the Federal Reserve to
extend new loans.
– A reduction in the discount rate increases the
money supply (expansionary) because it makes
borrowing from the Federal Reserve less costly.
The 3 Tools the Fed Uses
to Control the Money Supply
(1)
Easy money policy (Expansionary)
(2)
Tight money policy (Contractionary)
Problem: unemployment and recession
Problem: inflation
Federal Reserve buys
bonds, lowers reserve ration, or
lowers the discount rate
Federal Reserve sells bonds, increases
reserve ratio, or increases the discount rate
Excess reserves increase
Excess reserves decrease
Money supply rises
Money supply falls
Interest rates fall
Interest rate rises
Investment spending increases
Investment spending decreases
Aggregate demand increases
Aggregate demand decreases
Real GDP rises by a multiple
of the increase in investment
Inflation declines
Monetary Policy Tools
REVIEW: TOOLS OF MONETARY POLICY
Open-Market Operations
The Reserve Ratio
The Discount Rate
What will happen to the money
supply in the following situations?
Examples:
•Buy securities
•Sell Securities
MONEY INCREASES
MONEY DECREASES
•Increase Reserve Ratio
•Decrease Reserve Ratio
MONEY DECREASES
•Raise Discount Rate
MONEY DECREASES
MONEY INCREASES
•Lower Discount Rate
MONEY INCREASES
How Banks Create Money
by Extending Loans
Fractional Reserve Banking
• The U.S. banking system is a fractional
reserve system where banks maintain
only a fraction of their assets as reserves
to meet the requirements of depositors.
• Under a fractional reserve system, an
increase in reserves (excess reserves)
will permit banks to extend additional
loans and thereby expand the money
supply (by creating additional checking
deposits).
Creating Money from New Reserves
New cash
deposits:
Actual Reserves
Bank
Initial deposit (bank A)
Second stage (bank B)
Third stage (bank C)
Fourth stage (bank D)
Fifth stage (bank E)
Sixth stage (bank F)
Seventh stage (bank G)
All others (other banks)
Total
New
Required Reserves
Potential demand
deposits created by
extending new loans
$1,000.00
800.00
640.00
512.00
409.60
327.68
262.14
1,048.58
$200.00
160.00
128.00
102.40
81.92
65.54
52.43
209.71
$800.00
640.00
512.00
409.60
327.68
262.14
209.71
838.87
$5,000.00
$1,000.00
$4,000.00
• When banks are required to maintain 20%
reserves against demand deposits, the creation of
$1,000 of new reserves will potentially increase
the supply of money by $5,000.
What is the Purpose of changing the
Money Supply?
• The assumption is that the increased excess reserves
from an expansionary monetary policy are going to
be loaned out and going to be used to purchase
Goods/Services – INCREASING GDP (Recession, less
than full-employment)
• The assumption is that the decrease in excess
reserves from a contractionary monetary policy are
going to decrease loans and is going to discourage
the purchases of Goods/Services – DECREASING GDP
(Inflation, greater than full-employment)
The Money-Supply Multiplier
• From this example, we see that there is a new
kind of multiplier operating on bank reserves
– a money-supply multiplier very different
from the Keynesian expenditure multiplier.
The Money Multiplier: II
• MoneyMultiplier = 1/ ReserveRatio
• So in the example above, if RR is .10, Money
Multiplier is ten.
– And ten times the original $1,000 increase in
demand deposits is $10,000.
Page down to advance
the presentation
The Money Multiplier: III
• Now suppose the RR is instead 50%, what’s
the money multiplier?
Page down to advance
the presentation
The Money Multiplier: III
• That’s right, it’s two – one divided by .50.
• So if Bank 1 receives a new demand deposit
of $1,000, it can lend out $500, Bank 2 can
lend out $250, and so on until a total of
$2,000 of new money is in circulation.
Page down to advance
the presentation
The Money Multiplier Point
• The bigger the RR, the smaller the MM and
the less money created by a new dollar of
demand deposits.
Page down to advance
the presentation
How Banks Create Money
by Extending Loans
• The lower the percentage of the reserve requirement, the
greater the potential expansion in the money supply
resulting from the creation of new reserves.
• The fractional reserve requirement places a ceiling on
potential money creation from new reserves.
• The actual deposit multiplier will be less than the
potential because:
– Some persons will hold currency rather than bank
deposits.
– Some banks may not use all their excess reserves to
extend loans.
Government in the Economy
• Nothing arouses as much controversy as
the role of government in the economy.
• Government can affect the
macroeconomy in two ways:
– Fiscal policy is the manipulation of
government spending and taxation.
– Monetary policy refers to the behavior of
the Federal Reserve regarding the nation’s
money supply.
What is Fiscal Policy?
• Fiscal policy is the
deliberate manipulation of
government purchases,
transfer payments, taxes,
and borrowing in order to
influence macroeconomic
variables such as
employment, the price
level, and the level of GDP
Government in the Economy
• Discretionary fiscal policy refers to deliberate
changes in taxes or spending.
• The government can not control certain aspects of
the economy related to fiscal policy. For example:
– The government can control tax rates but not tax
revenue. Tax revenue depends on household
income and the size of corporate profits.
– Government spending depends on government
decisions and the state of the economy.
Fiscal Policy in Practice
Introduction
• Before the 1930s, fiscal policy was not explicitly used to influence the
macroeconomy
– The classical approach implied that natural market forces, by way of
flexible prices, wages, and interest rates, would move the economy
toward its potential GDP
– Thus there appeared to be no need for government intervention in the
economy
• Before the onset of the Great Depression, most economists believed
that active fiscal policy would do more harm than good
The Great Depression and World War
II
• Three developments bolstered the use of fiscal policy
– The publication of Keynes’ General Theory
– War-time demand on production helped pull the U.S. out of the
Great Depression
– The Full Employment Act of 1946, which gave the federal
government responsibility for promoting full employment and
price stability
•
•
Automatic Stabilizers
Structural features of government
spending and taxation that smooth
fluctuations in disposable income over the
business cycle
Examples include,
– Our progressive income system with its
increasing marginal income tax rates
– Unemployment insurance
– Welfare spending
Supply side shocks
The level of national income can change in short term if there is a supply-side shock.
Many factors can bring about a changes in supply, including changes in following:
1.Wage levels, which affect firms’ unit labour costs.
2.Other costs of production, such as commodity prices, or which changes in oil
prices are significant.
3.Indirect taxes, such as VAT.
4.Subsidies.
5.Productivity of factors, especially labour.
6.Changes in the use of technology and production methods.
7.Direct taxes, such as income tax, via an incentive or disincentive effect.
8.Length of the working week.
9.Labor migration.
http://www.economicsonline.co.uk/Managing
_the_economy/Supply_side_shocks.html
The Golden Age of Keynesian Fiscal
Policy to Stagflation
• The Early 1960s provided support for Keynesian theories
– In particular, President Kennedy’s 1964 income tax cut did much to
boost the economy and reduce unemployment
• However, the 1970s were marked by significant supply-side
shocks (increases in oil prices in addition to crop failures)
– The economic ills brought about by these supply-side shocks to the
economy could not be remedied by demand-side Keynesian
economic theories
Supply side shocks cause cyclical instability by shifting short-run aggregate supply (SRAS)
although they are unlikely to have any major impact on the long-run productive potential of
the economy. A negative supply-side shock might be caused by a rise in world oil prices - over
the last thirty years there have been several occasions when the international price of crude oil
has moved sharply higher causing major effects on the economies of countries across the
global economy. The rise in oil prices has causes an increase in the variable costs of firms for
whom oil is an essential input into the production process. For this reason firms may seek to
raise their prices to protect their profit margins
Lags in Fiscal Policy
• The time required to approve and implement fiscal
legislation may hamper its effectiveness and weaken fiscal
policy as a tool of economic stabilization
• In the case of an oncoming recession, it may take time to
– Recognize the coming recession
– Implement the policy
– Let the policy have its impact
Discretionary Policy and
Permanent Income
• Permanent income is
income that individuals
expect to receive on
average over the long run
• To the extent that
consumers base spending
decisions on their
permanent income,
attempts to fine-tune the
economy through
discretionary fiscal policy
will be less effective
Budgets, Deficits,
and Public Policy
The Government Budget
• A plan for government
expenditures and
revenues for a
specified period,
usually a year
The Federal Budget
• The federal budget is the budget of the
federal government.
• The difference between the federal
government’s receipts and its expenditures is
the federal surplus (+) or deficit (-).
The Federal Budget
There is one tax here that you probably do not know…. Be honest….
Excise tax
Tobacco, alcohol and gasoline
These are the three main targets of excise taxation in most countries around the world. They
are everyday items of mass usage (even, arguably, "necessity") which bring huge profits for
governments. The first two are considered to be legal drugs, which are a cause of many
illnesses, which are used by large swathes of the population, with tobacco being widely
recognized as addictive. Gasoline (or petrol), as well as diesel and other fuels, meanwhile,
despite being indispensable to modern life, have excise tax imposed on them mainly because
they pollute the environment.
Narcotics
Many US states tax illegal drugs.
Gambling
Gambling licences are subject to excise in many countries; however, gambling itself was for a
time also subject to taxation, in the form of stamp duty, whereby a revenue stamp had to be
placed on the ace of spades in every pack of cards to demonstrate that the duty had been
paid.
Taxes & Government Spending
• Entitlement Programs:
– Entitlements – social welfare programs that
people are “entitled to” if they meet certain
eligibility requirements. i.e. age or income
– Mandatory spending increases as more and more
people qualify for the money.
– Some of the entitlement programs are “meanstested”, that means people with higher
incomes may receive lower benefits or no
benefit at all.
Taxes & Government Spending
– Entitlements are a largely unchanging part of
government spending.
– Once Congress has set the requirements, it cannot
control how many people become eligible
for each king of benefit.
– Congress can change the eligibility requirements
or reduce the amount of the benefits.
Taxes & Government Spending
• Social Security
– This is the largest category of federal spending.
– More than 50 million retired or disabled people
and their families and survivors receive
monthly payments.
Taxes & Government Spending
• Medicare
– Medicare serves about 40 million people, most of
them over the age of 65.
– This program pays for hospital care and for the
costs of the physicians and medical
services.
– Also pays for disabled people and those suffering
from certain diseases.
– It is funded by taxes withheld from your paycheck
Taxes & Government Spending
• Medicaid
– It benefits low-income families, some people with
disabilities, and elderly people in nursing
homes.
– It is the largest source of funds for medical and
health-related services for America’s
poorest people.
Taxes & Government Spending
• Other Mandatory Spending Programs
– These include
• Food Stamps
• Supplemental Security Income (SSI)
• Child Nutrition
Taxes & Government Spending
• Future of Entitlement Spending
– Spending for both Social Security and Medicare
have increased enormously.
– It is expected to increase even more in the future
as the “baby-boomers” began to collect.
Entitlement spending
http://www.youtube.com/watch?v=JsTbkB9hO
uw
The Presidential Role in the Budget
Process
• Early in this century, the president had very little
involvement in the development of the federal budget
• By the mid-1970s the president had been given the
resources to translate policy into a budget proposal to be
presented to Congress
– Office of Management and Budget (1921)
– Employment Act of 1946 (Council of Economic Advisers)
The Presidential Role in the
Budget Process (continued)
•
The development of the
president’s budget begins a
year before it is submitted to
Congress
– The presidents proposed
budget (The Budget of the
United States Government) is
supported by the Economic
Report of the President
•
The budget is submitted in
January for the upcoming fiscal
year October 1-September 30
The Congressional Role in the Budget
Process
• House and Senate budget committees review the
president’s budget proposal
• An overall budget outline is approved by Congress (budget
resolution) and given to the various congressional
committees and subcommittees which authorize federal
spending
Budget Deficits and Surpluses
• When budgeted
expenditures exceed
projected tax revenues, the
budget is projected to be in
deficit
• When projected tax
revenues exceed budgeted
expenditures, the budget is
projected to be in surplus
Suggestions for Budget Reform
• Biennial budget
• The elimination of line item
details before Congress
– Congress would consider
only the overall budget for
a given agency, rather that
detailed line items
Rationale for Budget Deficits
• Large capital projects (highways, etc.)
– The benefits from these project will benefit more than current taxpayers,
so deficit financing is appropriate
• Major Wars
• Keynesian economics points to the use of deficits to stimulate the
economy during periods of economic slowdown
• Automatic stabilizers tend to increase deficits, since during times of
recession, taxes are reduced while unemployment insurance and
welfare payments are increased
Budget Philosophies
• Annually balanced budget—Budget philosophy prior to the
Great Depression; aimed at equating revenues with
expenditures, except during times of war
• Cyclically balanced budget—Budget philosophy calling for
budget deficits during recessions to be financed by budget
surpluses during expansions
• Functional Finance—A budget philosophy aiming fiscal
policy at achieving potential GDP rather than balancing
budgets either annually or over the business cycle
Crowding Out and Crowding In
• Crowding out--When the government undertakes
expansionary fiscal policy, interest rates increase due to
competition for borrowed funds and increased transactions
demand for money
– As a result, private investment is “crowded out” due to increases in
public investment
• Crowding in—If expansionary fiscal policy raises the general
level of prosperity in the economy, private investors may
expect greater investment-related profits, causing private
investment to increase
The Federal Deficit Versus the National
Debt
• The federal deficit is a flow variable measuring the amount
by which expenditures exceed revenues in a particular year
• The national debt is a stock variable measuring the
accumulation of past deficits
• In the U.S., it took 200 years for the national debt to reach
$1 trillion
– After the debt reached this level, it took only 15 years for the debt
to reach the $5 trillion level
The Debt and Problems
• http://www.brillig.com/debt_clock/
• Arguments about the Debt
– We have to pay it back
– We owe it to ourselves (much less so than years
ago).
Size of Government
Reducing the Deficit
•
Line-item veto (signed into law
in April 1996 struck by the
Supreme Court in 1998)
– A provision to allow the
president to reject particular
portions of the budget rather
than simply accept or reject
the entire budget
•
Balanced budget amendment
– Proposed amendment to the
U.S. Constitution requiring a
balanced federal budget
Five Debates over
Macroeconomic Policy
Chapter 34
Five Debates over Macroeconomic Policy
1. Should monetary and fiscal policymakers
try to stabilize the economy?
2. Should monetary policy be made by rule
rather than by discretion?
3. Should the central bank aim for zero
inflation?
Five Debates over Macroeconomic Policy
4. Should the government balance its
budget?
5. Should the tax laws be reformed to
encourage saving?
1. Should Monetary and Fiscal
Policymakers Try to Stabilize the
Economy?
Pro: Policymakers should try to stabilize
the economy
u The economy is inherently unstable, and
left on its own will fluctuate.
u Policy can manage aggregate demand in
order to offset this inherent instability and
reduce the severity of economic
fluctuations.
Pro: Policymakers should try to stabilize
the economy
u There is no reason for society to suffer
through the booms and busts of the
business cycle.
u Monetary and fiscal policy can stabilize
aggregate demand and, thereby,
production and employment.
Con: Policymakers should not try to
stabilize the economy
u Monetary policy affects the economy with
long and unpredictable lags between the
need to act and the time that it takes for
these policies to work.
u Many studies indicate that changes in
monetary policy have little effect on
aggregate demand until about six months
after the change is made.
Con: Policymakers should not try to
stabilize the economy
u Fiscal policy works with a lag because of the
long political process that governs changes in
spending and taxes.
u It can take years to propose, pass, and
implement a major change in fiscal policy.
Con: Policymakers should not try to
stabilize the economy
u All too often policymakers can inadvertently
exacerbate rather than mitigate the
magnitude of economic fluctuations.
u It might be desirable if policy makers could
eliminate all economic fluctuations, but this is
not a realistic goal.
2. Should Monetary Policy Be
Made by Rule Rather Than by
Discretion?
Pro: Monetary policy should be made by
rule
u Discretionary monetary policy can suffer from
incompetence and abuse of power.
u To the extent that central bankers ally
themselves with politicians, discretionary
policy can lead to economic fluctuations that
reflect the electoral calendar – the political
business cycle.
Pro: Monetary policy should be made by
rule
u There may be a discrepancy between what
policymakers say they will do and what they
actually do – called time inconsistency of
policy.
u Because policymakers are so often time
inconsistent, people are skeptical when
central bankers announce their intentions to
reduce the rate of inflation.
Pro: Monetary policy should be made by
rule
u Committing the Fed to a moderate and
steady growth of the money supply would
limit incompetence, abuse of power, and
time inconsistency.
Con: Monetary policy should not be made
by rule
u An important advantage of discretionary
monetary policy is its flexibility.
u Inflexible policies will limit the ability of
policymakers to respond to changing
economic circumstances.
Con: Monetary policy should not be made
by rule
u The alleged problems with discretion and
abuse of power are largely hypothetical.
u Also, the importance of the political business
cycle is far from clear.
3. Should The Central Bank Aim
for Zero Inflation?
Pro: The central bank should aim for zero
inflation
u Inflation confers no benefit to society, but it
imposes several real costs.
u
u
u
u
u
u
Shoeleather costs
Menu costs
Increased variability of relative prices
Unintended changes in tax liabilities
Confusion and inconvenience
Arbitrary redistribution of wealth
Pro: The central bank should aim for zero
inflation
u Reducing inflation is a policy with temporary
costs and permanent benefits.
u Once the disinflationary recession is over, the
benefits of zero inflation would persist.
Con: The central bank should not aim for
zero inflation
u Zero inflation is probably unattainable, and to
get there involves output, unemployment, and
social costs that are too high.
u Policymakers can reduce many of the costs of
inflation without actually reducing inflation.
4. Should Fiscal Policymakers
reduce the Government Debt?
Pro: The government should balance its
budget
u Budget deficits impose an unjustifiable
burden on future generations by raising
their taxes and lowering their incomes.
u When the debts and accumulated interest
come due, future taxpayers will face a
difficult choice:
u
They can pay higher taxes, enjoy less
government spending, or both.
Pro: The government should balance its
budget
u By shifting the cost of current government
benefits to future generations, there is a bias
against future taxpayers.
u Deficits reduce national saving, leading to a
smaller stock of capital, which reduces
productivity and growth.
Con: The government should not balance
its budget
u The problem with the deficit is often
exaggerated.
u The transfer of debt to the future may be
justified because some government
purchases produce benefits well into the
future.
Con: The government should not balance
its budget
u The government debt can continue to rise
because population growth and
technological progress increase the nation’s
ability to pay the interest on the debt.
5. Should The Tax Laws Be
Reformed to Encourage Saving?
Pro: Tax laws should be reformed to
encourage saving
u A nation’s saving rate is a key determinant of
its long-run economic prosperity.
u A nation’s productive capability is determined
largely by how much it saves and invests for
the future.
u When the saving rate is higher, more resources
are available for investment in new plant and
equipment.
Pro: Tax laws should be reformed to
encourage saving
u The U.S. tax system discourages saving in
many ways, such as by heavily taxing the
income from capital and by reducing
benefits for those who have accumulated
wealth.
Pro: Tax laws should be reformed to
encourage saving
u The consequences of high capital income
tax policies are reduced saving, reduced
capital accumulation, lower labor
productivity, and reduced economic
growth.
Pro: Tax laws should be reformed to
encourage saving
u An alternative to current tax policies
advocated by many economists is a
consumption tax.
u With a consumption tax, a household pays
taxes based on what it spends not on what it
earns.
u
Income that is saved is exempt from taxation until
the saving is later withdrawn and spent on
consumption goods.
Con: Tax laws should not be reformed to
encourage saving
u Many of the changes in tax laws to
stimulate saving would primarily benefit
the wealthy.
u
u
High-income households save a higher fraction
of their income than low-income
households.
Any tax change that favors people who save
will also tend to favor people with high
incomes.
Con: Tax laws should not be reformed to
encourage saving
u Reducing the tax burden on the wealthy
would lead to a less egalitarian society.
u This would also force the government to
raise the tax burden on the poor.
Con: Tax laws should not be reformed to
encourage saving
u Raising public saving by eliminating the
government’s budget deficit would provide
a more direct and equitable way to increase
national saving.
Summary
u Advocates of active monetary and fiscal policy
view the economy as inherently unstable and
believe policy can be used to offset this
inherent instability.
u Critics of active policy emphasize that policy
affects the economy with a lag and our ability
to forecast future economic conditions is poor,
both of which can lead to policy being
destabilizing.
Summary
u Advocates of rules for monetary policy
argue that discretionary policy can suffer
from incompetence, abuse of power, and
time inconsistency.
u Critics of rules for monetary policy argue
that discretionary policy is more flexible in
responding to economic circumstances.
Summary
u Advocates of a zero-inflation target
emphasize that inflation has many costs
and few if any benefits.
u Critics of a zero-inflation target claim that
moderate inflation imposes only small costs
on society, whereas the recession necessary
to reduce inflation is quite costly.
Summary
u Advocates of reducing the government
debt argue that the debt imposes a burden
on future generations by raising their taxes
and lowering their incomes.
u Critics of reducing the government debt
argue that the debt is only one small piece
of fiscal policy.
Summary
u Advocates of tax incentives for saving point out
that our society discourages saving in many ways
such as taxing income from capital and reducing
benefits for those who have accumulated wealth.
u Critics of tax incentives argue that many
proposed changes to stimulate saving would
primarily benefit the wealthy and also might
have only a small effect on private saving.