Transcript fiscal & monetary policy

Chapters 15 & 16
• TWO TOOLS:
• Fiscal & Monetary Policy
• What’s the difference?
• Fiscal Policy = Taxing & Spending
• Monetary Policy = manipulating
the money supply
• FISCAL POLICY = The Budget:
• The use of government
spending and revenue collection
to influence the economy
• Fed. government regulating
taxes & spending – Public control
• The federal government makes
key fiscal policy decisions
each year when it establishes
the 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, 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
• 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
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 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.
• So… the only way to end the Depression,
would be to find a way to boost demand.
• Government should step in and spend
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.
Demand-side
Economics
• 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 difference between expenditures and revenues
in one year.
• So … it will equal the amount of money the government
borrows for one fiscal year
• The debt is the sum of all government borrowing before that
time (minus the borrowing that has already been repaid)
• So… every year that there is a budget deficit, the federal
government borrows money to cover it and the national debt
then 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, like 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
Manipulating the Money Supply
•
Managed by the Federal Reserve Board (1913)
• Board of Governors appointed by P and confirmed
by Senate & serve 14-yr. terms – why such long
terms?
•
•
insulation from political pressure
Acts independently of government & regulates
monetary policy in 3 ways
1.Manipulating the interest rate at which loans are given
2.Manipulating the amount of reserves --- $ banks must have
available
3.Manipulates the money supply with bond sales/purchases
STRUCTURE OF THE FED
Owned by member banks
-all national banks
-some state banks
Twelve Districts with Directors/
Presidents
-but supervised by Fed in DC
Board of Governors – 7 members
-appointed by P & approved by Senate
-14 year terms, staggered
Federal Open Market Committee
-money supply & interest rates
-12 voting members meet 8 x year
Federal Advisory Council
-gives advice on overall economic health
Chairperson
Janet Yellen
The Federal Reserve System
MONETARY POLICY:
It’s all about:
Interest rates
Money supply
Reserve requirements
Margin requirements
A main role of the FED is to keep up
consumer confidence in the banking
system!
The Federal Reserve System
Responsibilities of the Fed
REGULATE BANKS
• Approve mergers
• Enforce truth-in-lending laws
• Examine Banks
• SET RESERVE & MARGIN
REQUIREMENTS
• SERVE BANKS
• Check clearing
• Lender of last
resort
FED
• REGULATE $ SUPPLY
• Adjust money supply
to stabilize the
economy
• SERVE GOVERNMENT
• Issuing Currency & Storing
Cash
• Selling, transferring,
redeeming gov’t securities
• Treasury Dept. Checking
Account
• The Fed’s most
visible function is
its check-clearing
responsibilities.
• The Fed can clear
millions of checks
at any one time
using high-speed
equipment.
How long does it take most
checks to clear?
• Gold reserves in the
Federal Reserve Bank of
New York

Federal Reserve vaults in
Dallas
Federal Open Market Committee & Money Supply
Government sells bonds Money flows to the treasury - reduces the money supply
in circulation
Government redeems (buys back) bonds Money flows out of the treasury - increases the money
supply
Fractional Reserve System & Money Supply
Allows the Fed to control the growth of the money supply.
A percentage of each deposit into a bank account
must be kept in the bank. The remainder can be
loaned out.
The Fed determines the percentage – called the
reserve requirement
• A lower reserve fraction results in more monetary
expansion
•A higher reserve fraction results in less monetary
expansion
Formula: Deposit x 1 divided by RR = increased money supply
$50,000