Transcript Fiscal policy

Unit 7
Fiscal & Monetary Policy
The Federal Reserve System
• The central bank of the US which sets the monetary policy
of the USA
• Monetary policy-control over the money supply and
interest rates to dampen inflation or to stimulate growth
• The Fed holds reserves of all other banks in its vaults
• Reserve requirement- the regulation that banks must keep
a certain percentage of deposits on hand to repay
depositers
• Provides loans to banks when they need it
• Provides check clearing between different banks
• Manages the banking system using the 12 regional Federal
Reserve Banks
Fiscal Policy
• The federal government uses fiscal policy to
regulate the economy
• Fiscal policy- the government’s ability to tax
and spend to get a stagnant economy going or
to fight inflation
Great Depression
• Classical economists believed in the ideas of
Adam Smith; that the government should stay
out of the economy and keep taxes low
• Because of this idea prior to the Great
Depression, government rarely got involved in
the economy in a substantial way
• The Great Depression caused such widespread
misery that people in America wanted their
government to get involved to stabilize the
economy
Keynes
• Keynesian economics- the idea of British economist
John Maynard Keynes
• This idea is that recessions and depressions are caused
by a lack of buying power; put simply, people did not
have money to buy stuff which leads to a downward
cycle
• Keynes believed that the government should stimulate
the economy by lowering taxes and by the government
spending money to put more money in the economy
• He felt that the government should borrow money to
do this spending; not raise taxes to get it- this is called
deficit spending
The New Deal
• FDR used deficit spending to increase demand
and promote economic growth; these policies
were called the New Deal
• 1939-1945 the federal deficit went from 3
Billion to 47 Billion
• Unemployment dropped from 17 to 2 percent
and our GDP almost doubled
Friedman
• Milton Friedman believed that our monetary policy
was the reason for the depression
• Monetarism-the idea that the money supply is the
primary reason for ups and downs in the economy
• Too much money too fast results in inflation as
consumers with more money demand goods and
services faster than producers can provide them
driving prices up
• If the money supply grows too slowly, deflation occurs
and spending and investment slows down
• The goal of monetary policy should be to keep up with
economic growth-but no faster
Stagflation
• Monetarism as a policy device was put to the test in the
1970’s
• The oil embargo drove gas prices up which caused
businesses to slow their activity while inflation soared
• Stagflation- when the economy is stagnant, there is high
unemployment and there is high inflation at the same time
• Paul Volker (Fed Chairman and Friedman follower) decided
to use a tight-money policy to help slow inflation.
• Tight-money policy- a slowing of the growth of the money
supply (contractionary fiscal policy)
• Inflation dropped but the resulting high interest rates
caused an even bigger drop in business activity and
unemployment hit 11%
• Many economists now believe that the government should
use both monetary and fiscal policy to help keep the
economy stable
Demand Side Economics
• Keynesian idea that the best way to stimulate
the economy is to cut taxes across the board
to put more money in everyone’s pocket &
increase government spending
• This is expansionary fiscal policy
• Demand side economists believe in the
multiplier effect- dollars spent will eventually
multiply and benefit others in the economy
Supply Side Economics
• Supply side economists believe that the best way to
deal with an economic slowdown is to stimulate overall
supply by cutting taxes on businesses and high-income
taxpayers
• The idea is that businesses and investors will use the
money from their tax savings to expand production,
the supply of goods and services will increase, spurring
economic growth
• “Trickle down economics”-Ronald Reagan used Supply
Side economics to cut taxes on businesses and the
wealthy in the early 80’s to try to grow the economy
National Debt
• The national debt is the debt accumulated
when our yearly budgets run a deficit
• Yearly is called a budget deficit or budget
surplus
• Overall it is the national debt
• There are many people concerned about the
current size of our national debt
Concerns about the Debt
• Fear of Government bankruptcy
• Concern about the burden on future
generations
• Unease about foreign owned debt
• Crowding out effect- happens when
government borrowing drives interest rates up
so high that people are no longer willing to
borrow money to invest in businesses