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Chapter 16: Government and the Economy Why Is Government Involved in the Economy? • We continue to debate the proper role of the government in dealing with the economy. – At times, a less active government is seen as more important. – However, a more active government may seem necessary (e.g., airline industry bailout). The Role of Government • Managing the economy • Protecting the welfare and property of individuals • Regulating competition • Providing public goods Should Government Be Involved in the Economy? • What are the main arguments in the debate over the proper role of the government in the economy? Economic Theory • Laissez-faire capitalism • Keynesians • Monetarists Classical Economics • Adam Smith and The Wealth of Nations • The government that governs least is the government that governs best. • Government should not compete with the private sector. Keynesian Economics • The Depression was the product of declining demand. • Government could use deficit spending to fund programs to stimulate demand. • Government should reduce spending once the economy recovers. What Are the Goals of Economic Policy? • • • • • • Promote a strong and stable economy Promote business development Promote international trade Regulate industrial relations Protect the environment Protect consumers What Are the Tools of Economic Policy • Monetary policy – Discount rate – Reserve requirement – Open market – Federal funds rate • Fiscal policy – Taxation – Spending and budgeting • Regulation and antitrust • Subsidies and contracts Monetary and Fiscal Policy • Taxes • Fiscal policy – Budgeting and spending using subsidies and contracts – Deficit spending • Monetary policy – Use of credit and interest to control demand of money and consumption Monetary Policy • Monetary policy is exercised by the Federal Reserve Board. • Monthly adjustments in the interest rate are designed to stabilize the inflation rate and promote a stable economy. The Federal Reserve Board • The Federal Reserve System was created in 1913 – Federal Reserve Bank – Federal Reserve Board • Chairman (four-year term) • Six governors (fourteen-year terms) The Federal Reserve Board Monetary Strategies • Discount rate – The setting of interest on loans to member banks • Open market operations – The buying and selling of government securities • Reserve requirements – The amount of liquid assets and ready cash that banks are required to hold to meet depositors’ demands The Federal Government Other Strategies • Federal Funds Rate involves the interest rate on loans between banks. • FDIC • FSLIC Fiscal Policy • Fiscal policy is generally exercised by the president and Congress. • Taxing and spending levels are adjusted to affect the economy. Taxes • Taxes are used to redistribute money from one sector of society to another. • Taxes can also be used to encourage or discourage certain types of behavior. Taxation • Tariffs • Sixteenth Amendment (1913) – Authorizes Congress to tax incomes • Progressive taxation – Income tax • Regressive taxation – Sales tax – Social Security Regulation • Administrative regulations are rules made by regulatory agencies and commissions to control specific areas. – OSHA regulates workplace safety; noncompliance may result in fines or other penalties. Subsidies • Subsidies are government grants of cash or other valuable commodities to promote certain activities. – Crop subsidies used to promote stable crop levels Contracts • Contracts are agreements with individuals or firms in the private sector to purchase goods or services. – Military contracts used to develop defense systems The Politics of Economic Policy • A healthy economy is the goal of both parties. • However, differences exist as how best to achieve this objective in terms of political parties and interest groups.