Transcript Fiscal and Monetary Policy

fiscal and
monetary policy
It’s just like math; no one likes it, but we need it...
What is Fiscal Policy?
It all begins with our Federal Budget and the idea
that decides what amount of money we are going
to spend on programs and services for a given
fiscal year (Oct 1st - Sept 30th).
The budget is created by the President, but it has
to be approved by Congress due to checks and
balances. It takes a long time (usually 18 months)
to create and is a very complex process.
Fiscal Policy is essentially the use of SPENDING
and TAXES by the government to control the
economy. We use it once we have diagnosed the
country using the macroeconomic indicators.
There are two types of Fiscal Policy
Under Expansionary Policy, the
government will do two things:
Under Contractionary Policy, the
government will do two things:
1. Increase Spending
2. Decrease Taxes
1. Decrease Spending
2. Increase Taxes
The idea is that the economy will
grow because people will find more
jobs from increased spending and
because people are spending more
of their own money.
The idea is that the economy will
slow down because less activity is
occuring. This could help to
prevent things like inflation.
I still don’t get how this fixes things...
Fiscal policy relies on what we call the multiplier effect; this is the idea that every
dollar spent becomes one more dollar in the economy (since money is not
destroyed when spent, rather recycled).
If one guy spends
money, then part of what
he spends become
income for someone else
(since prices reflect
inputs like workers).
Then, if that guy spends
his income, part of what
he spends will become
income for a third guy
(though the amount will
be smaller).
This process repeats
over and over and over
again, so that initial
injection by the first guy
“multiplies” over time to
have a larger impact.
Seems simple, is it?
Yes and no. The general principal of fiscal policy is
easy to understand; we use spending and taxes to
speed up or slow the economy as we see necessary.
However, it is actually a complex process and there
are some issues with the process:
Entitlements
- benefits to people who meet eligibility
requirements; cannot be easily changed.
Prediction
- we never know what might happen next
week with the economy.
Delay
- once we set fiscal policy in motion, it takes
time to get through the system.
Coordination
- there are many pieces to the puzzle and
getting everyone to work together is hard.
Political Pressure
- no politician has complete control of their
efforts; they often have to appease others.
This is only half of the story, though.
Fiscal Policy is a great tool, but it is far from
perfect and it is simply not enough to make
sure that everything goes well in our economy.
What about Monetary
Policy, yo?
What is Monetary Policy?
Historically, even though they served the same
purpose, banks were privately owned and
controlled companies (like Target or Microsoft
today). This created some issues during bad times
(like the stock market crash) because banks had
no one to back them up if things went south.
Monetary policy was created to address consumer
confidence in banks and to help our banking
system become what it is today with the backing of
the Federal Reserve (the “Fed”).
Monetary Policy utilizes INTEREST RATES and
the MONEY SUPPLY to control the economy. We
also use it once we have diagnosed the country
using the macroeconomic indicators.
So, what is “The FED?”
It is ran by a board of seven members that serve
staggered, 14-year terms and are appointed by
Congress. The meet and decide all monetary policy in
the United States. Their chair (currently, Ben Bernanke)
is the spokesperson for the group to the public.
It is a banking system that is
headed by 12 major district
banks meant to serve the
nation and act as a failsafe.
Virtually every bank in
America is part of the system.
What does the FED do?
The FED has three main functions, but only two that comprise monetary policy.
1. Serving the Government: Acts as the checking account for the Federal
Government.
2. Regulating the Money Supply: When the government
wants to speed up the economy (make it grow), it buys
securities from banks. Because the banks now have the
money from selling the securities, it can now loan that
money to people and businesses and so the supply of
money in the economy increases.
Conversely, to slow down the economy, the FED will sell
securities to banks. The banks buy them because they
are guaranteed money in the long run, but because they
buy them, they don’t have as much money to lend out to
people and businesses and the money supply shrinks.
lol.omg.wtf.bbq
What does the FED do?
3. Bank Regulation: In addition to working with banks,
the FED also directly controls some aspects of the bank.
The FED is in direct control of INTEREST RATES, which
means it can control how much people choose to put in
the economy. If interest rates are set low, people are
more willing to take out loans and inject money in the
economy, which speeds up the economy and helps it
grow.
At the same time, if interest rates are raised, then people
don’t take out as many loans and there is less money
circulating, which slows the economy.
Do you know what I’m doing
to your mind right now?
What does the FED do?
The FED also controls the REQUIRED RESERVE RATIO
(RRR).
It’s generally
around 10%
Banks make money by loaning money and earning
interest. Therefore, to make as much money as
possible, it would make sense to loan out all their
money. This is problematic because if it loans out all its
money, then you could never get your money from the
bank. Thus, the Required Reserve Ratio is the amount
of money the bank is required to keep in cash, on hand
at all times (it is usually represented as a percentage).
If the FED wants to slow the economy, it raises the RRR
and then banks have to hold more cash and things slow
down. Conversely, the FED can speed things up by
lowering the RRR and allowing the banks to loan money.
Sounds complicated...anything else?
Along with all of this, there is the entirely unique
issue around the different types of interest rates:
First, there is the
Discount Rate. It is
the interest rate
that the FED
charges banks that
borrow money from
the U.S. treasury.
Then, there is the
Federal Funds Rate.
This is the interest
rate the banks
charge each other to
borrow money,
usually short-term.
There is also the
Prime Rate. This is
the interest rate that
banks charge to
their best customers
(usually
companies).
Currently 0.75%
Currently 0 - 0.25%
Currently 3.25%
None of these are
rates that you get to
look forward to
when you get a loan
for school or a car
or a house.
So what do I need to remember?
Essentially, there are two types of Monetary Policy:
Under Tight Money Policy, the
government will do three things:
Under Easy Money Policy, the
government will do three things:
1. Sell Securities to Banks
2. Raise Interest Rates
3. Raise Reserve Ratios
1. Buy Securities from Banks
2. Lower Interest Rates
3. Lower Reserve Ratios
The idea is that the economy
will slow because these things
shrink the money supply.
The idea is that the economy
will grow because these things
will increase the money supply.
What about
young money?
Any problems with this one?
Just like fiscal policy, there are some similar issues with monetary policy:
Timing
-sometimes the window for adjusting the
economy is tiny and we miss it.
Prediction
- we never know what might happen next
week with the economy.
Lagging
- once we set fiscal policy in motion, it takes
time to get through the system.