Transcript Monetary policies

Ch. 15/16
Fed. Gov’t uses
2 strategies to fight inflation
and/or unemployment to promote a healthy,
growing economy:
Fiscal
policies (Ch. 15)
Monetary policies (Ch. 16)
Policies
that try to increase output
(stimulate the economy) are called
expansionary policies
Policies
intended to decrease output
are called
contractionary policies
Ch. 15 Fiscal Policy
Fiscal Policy defined:
The use of gov’t spending
and
taxing to influence the economy
To understand FP
economics, one must know
the 20th century’s most brilliant economic
theorist…
John Maynard Keynes
Cambridge Univ. professor…world’s leading
econ thinker in the 1930’s
Keynesian Economics:
Gov’t. should use
its power to tax and to
spend to affect the economy.
Problem: Inflation
gov’t. should raise
taxes to decrease the
amount of money individuals and businesses
have available to spend.
Similarly, gov’t. should lower its
spending to
decrease available income.
Less income =
individuals
less spending by business and
lower demand
prices
 We
Fiscal Policy
have talked about inflation only…what about
Problem: Unemployment
 During
recessions, gov’t.
1. spends to create jobs + income
- income gets spent which stimulates the economy.
2. Decreases taxes to make more $
available to biz and individuals
Fiscal Policy When the Economy
is Healthy & Expanding
During
booming economic cycles, gov’t.
cuts back on its spending and raises
taxes
This puts the brakes on consumer
spending and helps to keep growing GDP
under control
Limits of Fiscal Policy
Increasing gov’t. spending is
not so simple:
1. 60% of fed’l. budget goes to entitlement
programs which are fixed by law (programs like
Social Security, Medicare, veteran’s
benefits)…gov’t cannot alter these payments.
So…any change in fed’l spending must come from
only ~ 40% of what is in the fed’l budget
A political football ?
As
we have seen so clearly in the past 2
years, gov’t. spending is viewed differently by
Democrats and Republicans (generally)
Keynesian econ applied:
During our recent recession, what course
of action did the Obama administration
push?
How have the Republicans responded?
Economics & Politics
As a VERY general statement, Democrats accept
Keynesian economics…that government intervention
is needed to cure an ailing economy…
Lawrence O’Donnell: host of
The Last Word (MSNBC)
Economics & Politics
And generally speaking, Tea Party
supporters disagree w/Keynesian
economics…that an economy free of gov’t.
intervention is the answer…
Rep. Steve King (R-Iowa) at the 2010
Virginia Tea Party Convention
Supply - Side Economics
Stresses
influence taxes have on the economy
The concept: lower tax rates on the wealthy and on
businesses will lead to higher output (supply will
increase)
Will lead to higher employment
Popularized by Pres. Ronald Reagan in 1980s
AKA: “trickle-down” economics
A different strategy:
Ch. 16
Monetary policy
Monetary Policy
Gov’t uses the Federal Reserve
to affect the economy…
The Federal Reserve
“the
Fed”
Federal Reserve System created 1913
- USA divided into 12 districts… each has a
federal reserve bank
- all US banks belong to the system
What does the Fed do ?
The Federal Reserve has 3 primary goals
Maintain long term economic growth
Maintain stable price levels
Maintain full employment
Main Functions of the Fed
1. Set the Capital Reserves requirement
the % of deposits banks must maintain in
cash

2. Set the “discount rate”
the interest rate banks pay to the Fed to
borrow money

Fed Functions (con’t.)
3. Open Market Operations*

Controlling the money supply…
1.
2.
*
Fed buys U.S. bonds to increase money supply
and stimulates the economy (expansionary
policy)
Fed sells U.S. bonds to decrease money supply
and slows the economy (contractionary policy)
Most used, most important used
The Fed buys securities when it wants to increase the
supply of money and credit, and sells securities when it
wants to reduce the flow
Applying Monetary Policy
When unemployment is a problem,
the Fed should adopt: (choose one)
(A) expansionary policy
(B) contractionary policy
Applying Monetary Policy (con’t.)
To expand (stimulate growth) the economy
the Fed could/should:
1. Reserve Reqs: LOWER them
2. Discount Rate: LOWER it
3. Open Mkt Ops: BUY BONDS
Applying Monetary Policy
When inflation is a problem, the Fed
should adopt: (choose one)
(A) expansionary policy
(B) contractionary policy
Applying Monetary Policy (con’t.)
To slow growth of the economy the Fed
could/should:
1. Reserve Reqs: RAISE them
2. Discount Rate: RAISE it
3. Open Mkt Ops: SELL BONDS
A few last thoughts on
Monetary Policy
As
we already discussed, the Federal Reserve is
the key player
It sets a key interest rate (called the discount rate:
what banks pay to borrow from the Fed)
The Prime Rate (what consumer loans are based
on) is tiered above the Fed Funds rate
3 Names to know:
Monetary
Policy = Milton Friedman
Fiscal Policy = John Maynard Keynes
 New Chairman of he Federal Reserve:
Janet Yellen
Classical Economics
What makes both fiscal policy and
monetary policy significant is that they
each mark a huge departure from
“classical economics”

The heart of classical economic theory is
that:
1. free markets will regulate themselves
thru the natural interaction between supply
and demand…markets will naturally seek
equilibrium
2. gov’t. intervention is NOT needed
Adam
Smith…David
Ricardo…Thomas Malthus were the
major architects of this theory that
dominated economic theory and
gov’t policies for more than a century
The
Great Depression challenged
this line of thinking because…
Connecting the dots…
During the
Great Depression, prices
plummeted
Classic econ says that demand should rise
with low prices which should cause
producers to produce more, creating a
need for higher employment…but it didn’t
Keynes argued that
neither business nor
consumers had the ability or desire to
spend
Government MUST be the catalyst…it
was the only entity that had the ability to
spend to stimulate the economy
So…gov’t. can intervene with either
fiscal policy, monetary policy, or both….
Tying it all together
Keynes’ belief that gov’t HAD
to act has guided
our gov’ts actions for 75 years:
When inflation is
the problem:
contractionary policies are needed
When unemployment is
the problem:
expansionary policies are needed
Chap.
15/16 Quiz
Thurs 4/24 and Fri 4/25
Do the reading (including the
“supplemental readings”)
Do the Study guide
You can use the “cheat sheet”
handed out in class