Download ECONOMIC POLICY

Understanding how our elected officials work with one
another and other agencies to formulate economic
policy and the federal budget.
Part 1
 Health of American economy generates majoritarian politics
(everyone wants increases in wealth and income).
 Voters see connections between the nation as a whole and
their own well-being.
 Voting behavior and economic conditions are not always
correlated at the national and individual levels – people do not
always vote based on their pocketbooks
– People understand what government can and cannot be
held accountable for
– People see economic conditions having indirect effects on
them
 Many officials take economic policy positions based either on
ideological grounds or on their reading of public opinion.
 Elected officials are often tempted to take a short-term
approach of the economy and to adapt those policies that will
best satisfy the self-regarding voter.
 Government will not always do whatever is economically
necessary to win the election; government doesn’t know how
to produce desirable outcomes
– Reducing inflation by raising interest rates (could possibly
slow down the economy by hurting housing markets, etc.)
 Ideology plays a large role in shaping policy choices; higher
income people tend to be concerned with inflation; lower
income people tend to be more concerned with employment
 Believes inflation occurs when there is too much chasing too
few goods.
 Federal government has the power to create money;
according to Monetarists, inflation occurs when it prints too
much money.
 When inflation becomes rampant and government tries to do
something about it, it often cuts back sharply on the amount of
money in circulation. Then a recession will occur, with slowed
economic growth and an increase in unemployment.
 Advocates increasing the money supply at a rate about equal
to the growth of economic productivity; beyond that, it should
leave matters alone and let the free market operate.
 John Maynard Keynes; believed that the market will not
automatically operate at a full-employment, low-inflation level;
rather its health depends largely on what fraction of people’s
incomes they save or spend.
 Government should create the level of demand.
 When demand is too low, government should pump more
money into the economy (spending more than it takes in in
taxes and creating public works programs).
 When demand is too high, the government should take money
out of the economy (by increasing taxes or cutting federal
expenditures)
 Not concerned with balanced budget on year-to-year basis,
but rather on economic performance.
 Some view free market as too undependable to ensure
healthy economic activity; argue that government should
plan parts of a country’s economic activity when markets
fail to account for public good.
 Wage and price controls when markets are unable to
constrain inflation.
 Demand-side
 Others have argued that government should direct some
investments to needed industries that are unable to
attract private investment.
 Not as popular in the United States; often found in
European, Asian, and African economies.
 Stress there is a need for less government interference
in the market and for lower taxes – lower taxes create
incentives for investment, and the greater economic
productivity that results will produce more tax revenue
 Fits both libertarian and conservative political values
 Ignores political concerns about both inflation and
unemployment
 Combination of monetarism,  Effects of Reaganomics:
supply-side tax cuts, and
– Economy was stimulated
domestic budget-cutting.
 Wanted to reduce the size
of the federal government,
stimulate economic growth,
increase strength of the
military
 Inconsistencies were the
result of trying to combine
concerns about inflation,
economic freedom,
unemployment, and
increasing military spending
– Government spending continued to
increase, but at a slower rate than
before
– Military spending increased sharply
– Money supply was controlled, cutting
inflation but allowing interest rates to
rise
– Personal income taxes were cut, but
Social Security taxes were increased
– Large deficits incurred, dramatically
increasing the size of the national debt
– Several important industries (airlines
and telephone companies) were
deregulated.
Part 2
 Federal Reserve System (FED) was created by
Congress to regulate lending practices of banks and thus
the money supply.
 Made up of a Board of Governors (appointed by POTUS
and confirmed by the Senate); seven individuals given
fourteen year terms; Ben Bernanke is the current
Federal Reserve Chairman.
 Most important tool the government has to manage the
economy is its control of the money supply.
 M = supply of Money in economy
 V = velocity of money, or the number of times a year that the
average dollar is spent on final goods and services
 P = the overall price level in the economy, reflecting the
average price at which all output is sold
 Q = the quantity of all goods and services produced; also
known as REAL output.
 MV = PQ is a simple model of a marco economy during a time
period. MV represents the total amount spent by buyers in
the economy, and PQ represents the total amount received by
sellers, so the two must be equal. If there is a change in one
of the variables, there must be a change in one of the other
variables to keep MV equal to PQ

Government’s main economic policy is MONETARY POLICY (manipulation
of the money supply and credit).

Monetarism states that the supply of money is key to the nation’s economic
health.

How the FED works:
– Federal Open Market Committee (FOMC) meets eight times a year;
sets “Federal Funds Rate” (interest banks can charge each other for
overnight loans)
– FED purchases or sells government bonds from banks; by buying or
selling bonds form banks, the FED determines whether banks have
more or less money to lend out
– The more money banks have to lend, the cheaper borrowing is; if banks
have less to loan, loans become more expensive and interest rates go
up.
 FED can influence the state of the economy; the amount of money available,
interest rates, inflation, and the availability of jobs are all affected either
directly or indirectly by the complicated financial dealings of the FED.
 Fiscal policy (POTUS and Congress) outlines the impact
of the federal budget – taxes, spending, borrowing – on
the economy.
 Congress:
– Most important part of economic policy machine
– Approves taxes and almost all expenditures
– Can alter/influence FED by threatening to reduce
powers
– Can determine how high taxes should be and how
much money the government should spend
Part 3
 The budget is a document that announces how much the
government will collect in taxes and spend in revenues
and how those expenditures will be allocated among
various programs.
 Fiscal year runs from October 1 through September 30.
 Federal budget is a list of everything the government is
going to spend money on, with only slight regard (if any)
for how much money is available to be spent.
 President submits his budget in February, two budget
committees (one in House, one in Senate) study his overall
plan and obtain analysis from the CBO.
 Each committee then submits to its respective house a budget
resolution that proposes a total budget ceiling and a ceiling for
each of several spending areas.
 In May, Congress is supposed to adopt, with some
modifications, these budget resolutions, intending them to be
targets to guide the work of each legislative committee.
 During the summer, Congress then takes up the specific
appropriations bills, informing its members as it goes along
whether or not the spending proposal in these bills conforms
to the May budget resolutions (restrain committees).
 After each committee approves its appropriations bill and
Congress passes it, it goes to the POTUS for signature.
 About two-thirds of the spending is mandatory spending
(money goes to those entitled to it).
 Entitlements include social security, Medicare, VA
benefits, food stamps, and money the government owes
investors who have bought Treasury bonds.
 Government can alter only one-third of the federal
budget every year (discretionary spending).
 Nothing exists to ensure Congress tightens its budget
and spending.
 Called for automatic cuts from 1986–1991, until the federal
deficit disappeared
 If there was a lack of agreement between the president and
Congress on the total spending level, there would be
automatic across-the board cut (a sequester)
 The president and Congress still found ways to increase
spending (plan failed)
 By 1990, new plan emerged: (1) Congress would vote for a
tax increase, (2) Budget Enforcement Act of 1990 imposed a
cap on discretionary spending. As long as the POTUS and
Congress stay under the cap, they can change the amount of
money they spend.
– Imposed a “pay-as-you-go” approach and ultimately
helped restrain the debt.