Download Economic and Regulatory Policy

Lecture Notes:
LECTURE OUTLINE
I. What If . . . There Were No Social Security?
A. This feature presents a scenario in which students are asked to consider the possibility
of Congress eliminating the Social Security program for younger workers.
B. The outcome of such a proposal would depend largely on whether Congress would
eliminate the payroll tax it currently requires American workers to pay. If it did, this
would mean that many Americans could use the additional 16 percent of their
incomes to invest privately for their retirements.
C. Such a scenario might prove problematic when those younger workers without Social
Security retire. While some will have saved adequately for their retirement, others
will not have, or will have made risky investment choices and thus have inadequate
resources for their retirement.
D. In addition, eliminating Social Security would necessarily mean the elimination of
Medicare, wince Medicare is funded with Social Security taxes. This would mean that
individuals, in addition to providing for the own retirements, would have to pay for
private health insurance throughout their retirement years.
II. The Policy-Making Process
A. The first step in the policy-making process is identifying a problem. Numerous
problems exist, but their solutions are impossible until they are identified by
policymakers as problems. Typically this occurs through public debate. Policymakers
also rely on their constituents, friends, interest groups and the media to bring policy
problems to their attention.
B. The identification of a problem, the reaction to the problem and the solution all form
the policy process. There are five key steps in this process.
1. Agenda Building - This is the effort of identifying a problem and getting it on the
agenda. This may come about through crisis, or through the lobbying efforts of
interest groups or other concerned about the problem.
2. Policy Formulation - This consists of the debate that occurs among government
officials and the public in the media, in Congress and through campaigns.
3. Policy Adoption - This is the selection of a strategy for addressing the problem from
among the solutions discussed.
4. Policy Implementation - This is the administration of the policy adopted by
bureaucrats, the courts and others.
5. Policy Evaluation - Groups evaluate the policy to determine if it has had the desired
impact. The feedback also evaluates unintended consequences of the policy adoption.
The feedback is considered part of the agenda building and formulation process, so
that policy can be “fixed” if needed.
III. Poverty and Welfare
A. To define poverty, the government devised a system which defined poverty based on
a families income in comparison to the cost of a nutritious food plan. All families
whose income level was not at least a three times larger than the food plan were
classified as below the poverty line. Since 1969 when this initial calculation was
made, the government has revised the formula based on changes in the consumer
price index (CPI). In an attempt to assist these families, the government made
transfer payments to them in the form of programs like food stamps and housing
B.
C.
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vouchers. How effective these programs have been is hard to establish because of
dramatic changes that have taken place within society.
Because of societal changes there have been new groups that have added significant
numbers to the classification of people below the poverty level. Single-parent family
incomes are significantly less today in comparison to the 1960s. Furthermore, the
number of single-parent families has grown dramatically and this trend shows no
signs of abating. Nineteen percent of all children in America live in poverty and
children are 50 percent more likely than the rest of the population to be in poverty.
In an effort to resolve some of the most pressing problems of poverty, the federal
government has established the following programs:
Social Security provides monthly payment to people who are retired or unable to
work. This program was initiated in the 1930s to assist the elderly in society. Since
the inception of this program numerous changes have been made to provide more
service to a wider array of individuals within the society.
Supplemental Security Income (SSI) was established to provide a minimum income
for the aged, the blind, and the disabled.
Food Stamps are designed to provide adequate nutrition for families who cannot
afford to purchase necessary food items. The program began as a twofold mission to
help farmers to sell surplus products and to eliminate malnutrition.
Aid to Families with Dependent Children (AFDC) provided aid to children in poverty
who do not have two parents. This program was administered by state governments
but was financed by the federal government. This program was eliminated by the
Welfare Reform Act of 1996 and replaced with TANF.
Temporary Assistance to Needy Families (TANF) is a state-administered program in
which grants from the federal government are used to provide assistance to those
qualified to receive welfare benefits.
The Earned Income Tax Credit (EITC) helps lower-income workers by providing a
rebate on Social Security taxes paid to federal government. A criticism of the EITC
is that it has been disproportionately by part-time workers. Also, other critics contend
that it has done little to reduce the poverty rate.
The Welfare Reform Act of 1996 had several key components. Importantly it
provided for devolution of the welfare system, where the states receive federal funds
to address a problem that previously had been under the purview of the federal
government. The Act incorporated one major change -- most welfare recipients are
now limited to two years of assistance at one time, with a lifetime limit of five years.
The Act also provided incentives, in the form of “bonus payments,” to states that
reduce their rate of illegitimate births. The Act also allowed the states to deny
benefits to unmarried -teenage mothers.
The policies aimed at solving the problems of poverty and homelessness have been
controversial. Some programs have worked as intended while others have not
succeeded in accomplishing some the intended goals. Critics of the programs
contend the policies do not encourage people to remove themselves from poverty.
There is, according to some, an incentive to remain in poverty to avoid work. Other
critics point out that these programs have penalized people who are married. These
critics claim individuals will not get married in order to continue to receive benefits
from the government. Most recipients, as well as proponents of these programs, deny
that the people in poverty want to remain in poverty.
F. The problem of homelessness continues to be an important one, and many advocates
for the homeless argue that the Welfare Reform Act has exacerbated the problem.
Estimates are that on any given night there are anywhere from 230,000 to 750,000
people who are homeless. The fastest growing sub-group of the homeless are
families. The debate surrounding the policy issue of homelessness is couched in
ideological terms, as are the solutions to this problem.
IV. Crime in the Twenty-First Century
A. Crime has always been considered a problem in American society. On the one hand,
the public demands protection from criminals, but on the other, fair treatment from
the law enforcement officials. On numerous occasions these two desires come into
conflict. Law enforcement officials have been criticized from both extremes. When
violent crimes increase, the public demands the police take strong action to stop such
actions. When the police take actions to reduce violent crimes, they are often accused
of violating the rights of innocent people.
B. The cost for public safety from violent crimes is enormous. In most states the cost to
incarcerate an inmate is five times the amount spent to educate a child for a single
year. As prison populations increase so to will the cost to the taxpayers.
C. One of the major causes of crime in the U.S. is illegal drugs. Illegal drugs cause crime
because they result in turf wars between rival drug gangs, because they operate
outside the justice system and therefore resort to violence to settle disputes and
because drug addicts resort to crime to finance their drug habit. Money spent on
federal drug interdiction programs had not met with much success, as illegal drug
consumption in the U.S. has remained steady. State and local governments, however,
have been attempting new remedies to curtail the drug problem. One strategy includes
sentencing drug offenders to rehabilitation, rather than prison.
D. Probably the most devastating type of crime is terrorism because of its ability to
inflict violence on thousands of victims. After the attacks of September 11, 2001, the
federal government enacted many policies in an effort to combat terrorism, including
the war or terrorism. Some policies enjoyed widespread public support, others did
not. What seems clear, however, is that counter-terrorism strategies will necessarily
be a part of federal government policy for years to come.
V. Environmental Policy
A. The public had a growing awareness of environmental problems throughout the 1970s
and 1980s. Major environmental problems like oil spills and toxic waste sites have
led the government to formulate long-term policy aimed at protecting the
environment without causing major damage to the economy. The following polices
reflect the concern the government has for the need to protect the environment.
1. The National Environmental Policy Act was enacted in 1969 in an attempt to set
national standards for assessing the impact that major federal projects (construction of
roads, buildings, etc.) would have on the environment. Such projects could not be
started without first receiving an environmental impact statement (EIS).
2. The 1990 amendments to the Clean Air Act of 1963 constitute a comprehensive
policy mandating cleaner air in urban areas. Utility plants emission levels are
monitored and they must significantly reduce the amount of carbon monoxide
emissions. Automobile manufacturers must reduce emissions of nitrogen oxide must
progressively until 2007.
3. The Clean water Act of 1972 amended the Federal Water Pollution Control Act of
1948. The Clean Water Act sought to make waters safe for swimming, protect fish
and wildlife, and eliminate discharge pollutants into the water. The Clean Water Act
has proven controversial, however, because of its broad definition of “wetlands”
(which are subject to prohibitions on filling and dredging) and because of the
“migratory bird rule” (which ruled any waters suitable for use by migratory birds
were subject to regulation as wetlands).
B. Critics of our environmental policy contend that these restrictions cost jobs and
negatively affect the economy. Without doubt, there are substantial costs involved in
the new policies. But there are also substantial costs involved in not attempting to
resolve the environmental problems.
VI. The Politics of Economic Decision Making
A. Typically, in dealing with economic decisions, policy makers are asked to make
policy trade-offs. For example, the cost associated with shoring up Social Security
and Medicare by using the budget surplus means that policy makers would not be
able to use that money for a tax cut.
B. Taxes are a method used to raise revenue for the government. Subsidies are a
method used by the government to assist producers of a certain commodity. The
questions concerning both taxes and subsidies are related to who shall pay and who
shall receive. Action reaction syndrome states, “For every action on the part of the
government, there will be a reaction on the part of the public.”
C. The income tax code prior to 1986 was very complex and difficult to understand for
the average citizen. While the tax was in theory a progressive tax, there were
numerous loopholes that allowed high-income earners to avoid the high tax rates.
The 1986 Tax Reform Act made major revisions in the tax rates and attempted to
eliminate many of the so-called loopholes. Since the 1986 revisions various groups
have lobbied Congress to make significant alterations in the tax code. Many of the
recommendations by these groups have been enacted and because of these alterations
the tax policy is once again becoming complex.
D. Social Security was established in 1935 with the intent of providing a type of
insurance for a large segment of the public. Employees and their employers pay a tax
on a percentage of the employees’ wages. However, unlike private insurance
programs where the individual insured makes payments in to a account for his or her
own policy, the money paid into the Social Security program is used to provide
benefits for people who have already retired, or who are qualified to receive funds.
Initially for every recipient of Social Security there were forty workers paying into
the general fund- a 1 to 40 ratio. Had the ratio of recipients to workers remained the
same, there would have been few problems concerning Social Security.
E. Social Security depends upon the taxes paid by workers, which are used to purchase
bonds from the U.S. Treasury. Today, more money is paid in to Social Security than
is taken out. But this will not be the case when the baby boomers retire. This will
mean that some of the bonds will have to be sold. If no action is taken to correct this
imbalance, then eventually (some estimates say around 2030) all of the bonds will be
F.
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H.
I.
sold. This would mean that any benefits paid would have to come out of current-day
taxes.
Two major problems confront Social Security: 1) the ratio of recipients of Social
Security to workers has decreased dramatically; and 2) the life expectancy for
Americans has steadily increased and apparently will continue to increase. These two
factors have created a future scenario of inadequate funding in the current system
without some type of major revision.
One proposal for fixing Social Security is to raise taxes. This could be accomplished
by increasing the percentage of taxes withheld, or by eliminating the current cap on
wages to which the payroll tax is withheld. Such proposals however are limited in
their ability to fix Social Security in the long term.
Another proposal is to reduce benefit payouts. This could be done by increasing the
age of full eligibility to 70 or by imposing a means test for benefits.
Another proposal is to reform immigration policies so that more immigrants admitted
have highly valued skills for the workplace.
One major revision is privatizing social security. This proposal faces opposition
because many realize that there is a risk that comes from enabling people to invest
their own “safety net.” If an investment failed, then what would be the government’s
responsibility to provide for senior citizens who might be homeless and without
adequate income for food or medical necessities.
One proposal to increase the rate of return on Social Security contributions is a partial
privatization plan, whereby workers could opt to take 2 percent of their Social
Security payroll tax and invest to build their own retirement. This would mean that
people could have some control over their retirement nest egg, but could not
completely jeopardize their retirement income. There are numerous critics of this
plan, but it is clear that some sort of overhaul to Social Security is essential if the
system is to survive the retirements of the baby boomers.
Fiscal policy is concerned with accomplishing a specific economic goal through
government spending or taxation. Fiscal policy is often based on a particular
economic theory. During the Great Depression President Roosevelt relied on
Keynesian economic theory that advocated increased government spending during
economic recession or depression in order to stimulate the economy.
Monetary policy is concerned with the amount of money in circulation at a given
point in time. If there is an increase in the monetary supply there will be an increased
chance for inflation and an increased chance for lower interest rates. Conversely if
there is a decrease in the monetary supply there will be an increased chance for low
inflation and increased interest rates. However, a small change in the amount of
money in circulation may not be felt by the public for eighteen months after the
policy is altered.
In an attempt to have more ability to regulate the effect of monetary policy on the
private sector, Congress established the Federal Reserve in 1913. While the
president appoints members to serve on the Federal Reserve Board, he cannot replace
a member until the term of office expires. This action was intended to remove the
Fed from political pressure to stimulate the economy during election years for the
advantage of the president’s party. The importance of the Federal Reserve could be
seen in 1998 when the Federal Reserve lowered interest rates, and the response was
significant increases in stock indicators.
VII. Budget Deficits and the Public Debt
A. Until 1998, the national government had spent more money than it received for nearly
every one of the past 30 years. In 2002, however, the government again began
spending more money than it received. In all years but two from 1960-2002, the
national government ran at a deficit. If the deficit from every year is added, it is
possible to calculate the total amount of money the government owes to lenders. This
amount is referred to as the national debt.
B. The process by which the federal government finances its deficits is called public
debt financing. Typically this occurs when the government sells U.S. Treasury bonds.
The government sells bond to private individuals and companies who invest in the
U.S. government. One of the problems associated with public debt financing is that it
crowds out private borrowing (people don’t invest in private enterprises because they
use their income to invest in U.S. Treasury bonds). In addition, the need for the
government to offer high interest rates to investors further discourages investment in
private enterprise.
C. The debate surrounding budget deficits continued to rage during the 1990s, and some
advocated an amendment to the Constitution requiring a balanced budget. At the time,
it was thought that such an amendment would still require huge sacrifices on behalf of
the public in the form of reduced services and increased taxation. But in 1998, the
nearly unthinkable happened. The government operated without a deficit and even
generated a surplus. While many think that the balanced budget occurred because of
cuts in social spending, all analyses demonstrates that social spending increased,
despite the reputation of the Republican Congress as having reduced expenditures
significantly. In 1998, the budget was balanced through an increase in revenue
generated by taxes. With the recession of 2001 compounded by the terrorist attacks
on the United States, the tax revenue began to plummet, and expenditures increased
as the government spent money to combat terrorism (and aid additional programs in
the name of “security.”) These revenue reductions and increases in expenditures
indicate that the problem of deficit spending and increasing public debt is with us
once again.
VIII. America and the Global Economy
A. How powerful a country is depends on several factors. One of the most important
factors is the economic strength of the country. After WW II the United States was
the most economically powerful country. Beginning in the 1960s the U.S. faced
increased competition from Japan and West Germany in the sale of products on the
world market. Yet during the late 1990s, the United States again emerged as the
world economic leader, as many Asian economies faced crisis and European
economies stagnated.
B. How competitive the United States remains will depend in part on the scientific
knowledge for new products and the education level of the American workers to
adapt to the new technologies associated with these new products. If the government
does not encourage research for new products and does not invest in educational
programs to produce a technologically literate work force the economic position of
the country will likely continue to decline. This would mean the standard of living
for most Americans would also decline. The standard of living in the next century
will depend on the economic policies of today.
This chapter focuses on the economic role of the government, stressing its
promotion and regulation of economic interests and its fiscal and monetary
policies that affect economic growth. The main points made in the chapter are:
Through regulation, the U.S. government imposes restraints on
business activity which are designed to promote economic
efficiency and equity. This regulation is often the cause of political
conflict, which is both ideological and group-centered.
Through regulatory and conservation policies, the U.S. government
seeks to protect and preserve the environment from the effects of
business firms and consumers.
Through promotion, the U.S. government helps private interests to
achieve their economic goals. Business in particular benefits from
the government’s promotional efforts, which take place largely in
the context of group politics.
Through its taxing and spending decisions (fiscal policy), the U.S.
government seeks to maintain a level of economic supply and
demand that will keep the economy prosperous. The condition of
the economy is generally the leading issue in American electoral
politics and has a major influence on each party’s success.
Through its money-supply decisions (monetary policy), the U.S.
government—through the "Fed"— seeks to maintain a level of
inflation consistent with sustained controllable economic growth.
Although private enterprise is the main force in the American economic system,
the federal government plays a significant role through the policies it selects to
regulate, promote, and stimulate the economy.
Regulatory policy is designed to achieve efficiency and equity, which require
government to intervene, for example, to maintain competitive trade practices (an
efficiency goal) and to protect vulnerable parties in economic transactions (an
equity goal). Many of the regulatory decisions of the federal government,
particularly those of older agencies, are made largely in the context of group
politics; business lobbies have an especially strong influence on the regulatory
policies that affect them. In general, newer regulatory agencies have policy
responsibilities that are broader in scope and apply to a larger number of firms
than those of the older agencies. As a result, the policy decisions of newer
agencies are more often made in the context of party politics; Republican
administrations are less vigorous in their regulation of business than are
Democratic administrations.
The U.S. government has long been active in conservation, establishing the first
national park in 1872. Concern about pollution rose in the 1960s, and the
government responded by creating agencies such as the EPA and enacting
numerous programs and regulations to respond to those concerns. Although
debate continues about the scope of those efforts, the environment has definitely
benefited—the nation’s air and water are significantly cleaner than they were in
the 1960s. Environmental groups are among the nation’s most powerful interest
groups.
Business is the major beneficiary of the federal government’s efforts to promote
economic interests. Any number of programs, including those to provide loans
and research grants, are designed to assist businesses, which are also protected
from failure through such measures as tariffs and favorable tax laws. Labor, for
its part, gets government assistance through laws concerning such matters as
worker safety, the minimum wage, and collective bargaining; yet America’s
individualistic culture tends to put labor at a disadvantage, keeping it less
powerful than business in dealing with the government. Agriculture is another
economic sector that depends substantially on the government’s help,
particularly in the form of income stabilization programs.
Through its fiscal and monetary policies, the federal government attempts to
maintain a strong and stable economy—one that is characterized by high
productivity, high employment, and low inflation. (See OLC graphic, "Economic
Policy," at www.mhhe.com/patterson5.) Fiscal policy is based on government
decisions in regard to spending and taxing, which are aimed at either stimulating
a weak economy or dampening an overheated (inflationary) economy. Fiscal
policy is worked out through Congress and the president and is consequently
responsive to political pressures. However, because of the difficulty of either
raising taxes or cutting programs, there are limits to the government’s ability to
apply fiscal policy as an economic remedy. Monetary policy is based on the
money supply and works through the Federal Reserve System, which is headed
by a board whose members hold office for fixed terms. The Fed is a relatively
independent body, a fact that has given rise to questions as to whether it should
have such a large role in national economic policy.
Ch. 16 Economic Policy
Enduring Questions
1. Can the president make the country prosperous?
2. Why does the government ever have a budget deficit?
3. Why does it take so long for Congress to pass a budget?
By 1999 the national debt was over 5 million dollars, it was also the first time since the
1960s that there was no deficit; that year it stopped spending more money than it
collected in taxes.
Americans have long complained and told to stop the deficit. Politicians agreed with
voters but did little about it. Why? There are two camps 1. Those who thought the deficit
could be eliminated by cutting spending 2. Those who thought it could be eliminated by
raising taxes. In general, conservatives want to cut spending and liberals want to raise
taxes.
In 1996, the arguments between these groups were so intense that the Republican
Congress refused to pass Pres. Clinton’s spending plan and the president refused to sign
Congress’s spending bills. As a result, the government briefly ran out of money and
many agencies had to close their doors.
Although politicians often attempt to take credit for eliminating the deficit, the growing
and strong economy had flooded Washington with tax money.
Another problem arose: What should we do with the extra money? Republicans wanted
to give the surplus back to the people, Democrats wanted to use the surplus for new
programs.
George W. Bush wanted a tax cut that would total $1.6 trillion over ten years arguing the
national debt would be paid down and increase Medicare and education appropriations at
the same time.
Politicians hope to protect maintain Social Security --experts predict SS will start running
out of money in 2033.
The Office of Management and Budget and the Congressional Budget Office try very
hard to guess what our economic future will be, but they aren’t always accurate. (see
figure 16.1 Bad Economic Guesses)
Two kinds of economic issues face elected officials. First, the prosperity of the nation.
Second, how much money the government collects taxes and pays outh in benefits.
The Politics of Economic Prosperity
Money/Economy is always an issue just before an election. Low income people are more
likely to worry about unemployment and to vote Democratic, and higher income people
are more likely to worry about inflation (rise in prices/weakening purchasing power) and
to vote Republican. In 1992, people who felt the economic crisis were more likely to
vote for Clinton than Bush.
There is such uncertainty and complexity concerning the economy. It’s difficult to
determine what the federal government can or will do to reduce unemployment, cut
inflation, lower interest rates, and increase incomes just to win an election.
The Politics of Taxing and Spending
People want prosperity, no tax increases, no government deficit, and continued
government spending on education, medical care, and the environment, and retirement
benefits. Voters can’t possibly have it all because it is impossible to produce generous
spending on programs with low taxes and no deficit. Majoritarian Politics: Everybody
wants prosperity, and large majorities want more government spending on popular
programs.
By 1999, projected budget surpluses had produced three political responses: Tax cuts,
new programs or expand old programs, or reduce the debt.
How can taxes be raised without alienating voters?
You raise taxes on other people. The other people are always a minority of the voters.
For example, if you want to put more money into medical research, you raise taxes on
cigarettes. If you want to pay for new education programs, you increase taxes on
inheritances. In both cases, a minority of voters are affected. Some politicians target
ordinary citizens and specific activities such as education and childcare to justify
opposition to tax cut. Others hoping to lower rates look to the affluent people. Their
opponents say they are trying to “soak the rich” by denying tax cuts to the people who
now pay the biggest share of taxes.
Economic Theories
Presidents rely on economic advisers who generally accept one of the following:
I. Monetarism--the belief that inflation occurs when there is too much money chasing too
few goods. When the federal government creates too much money, inflation occurs.
When inflation becomes rampant the government trys to cut back on the amount of
money in circulation. Then a recession will occur--slowed economic growth and an
increase in unemployment. Monetarism suggests that government is responsible for
economic problems with its start and stop habit of issuing new money. Therefore
supporters of this policy recommend a steady, predictable increase in the money supply at
a rate about equal to the growth in the economy’s productivity; then leave matters alone.
(Milton Friedman)
II. Keynesianism
The health of the market depends on what fraction of people’s incomes they save or
spend. If people save too much, demand and then production decreases, unemployment
will rise as a result. If they spend too much, demand will rise too fast, prices will go up,
and shortages will develop. The key is to create the right level of demand. This is the
task of the government. When demand is too little, government should pump more
money into the economy by spending more than it takes it in taxes. When demand is too
great, the governmetn should take money out of the economy by increasing taxes or
cutting expenditures. The performance of the economy is paramount/most important but
Keynesians tend to favor an activist government.
(John Maynard Keynes)
III. Planning
The government should plan some part of the country’s economic activity. Economic
planning is price and wage controls. Big corporations can raise prices because the
forces of competition are too weak to restrain them, and labor unions can force up wages
because management finds it easy to pass the increases along to consumers in the form of
higher prices. Thus during inflationary times the government should regulate the
maximum prices that can be charged and wages that can be paid, at least in the larger
industries. (John Kenneth Galbraith)
Industrial Policy The government should somehow direct or plan investments so that
either these industries would recover or new and better industries would take their place.
(Robert Reich)
IV. Supply-Side Tax Cuts
Supporters believe that the market has not been given an adequate chance. Supply-Side
theory--less government interference in needed. For example, sharply cutting taxes will
increase the incentive to work, save and invest. Greater investments would led to more
jobs. More workers leads to more taxable income that adds to an increase in national
income. (Arthur Laffer and Paul Craig Roberts)
Socialist
Liberal
Conservative
Economic planning
Keynesian
Monetarism
Supply-side
“Reaganomics”
Involved a combination of monetarism, supply-side tax cuts, and domestic budget
cutting. Reagan hoped to reduce the size of the federal government, stimulate economic
growth, and increase American military strength. His ideas/goals seemed rather
inconsistent. Spending on domestic programs was reduced and military spending
increased, and there were tax cuts but increases in Social Security taxes. There was a
drop in unemployment and a rise in business activity. Reagan administration lowered
taxes and increased spending, and the national debt increased.
Fiscal policy--An attempt to use taxes and expenditures to affect the economy
budget deficit--government spends more than it takes in, thus pumping more money into
the economy.
budget surplus--government takes in more than it spends, thus draining money out of the
economy
monetary policy--an attempt to use the amount of money and bank deposits and the price
of money (the interest rate) to affect the economy.
fiscal year-- October 1 to September 30--the period of time for which federal government
appropriations are made and federal books are kept.
*At one time, every U.S. dollar was backed by gold--exchanged for gold. Today the
dollar is backed chiefly by public confidence rather than by a precious metal.
Economic Policy Making
Trioka--machinery making decisions about economic matters is complex and involves
three people other than the president. Chairman of Council of Economic Advisers
(CEA), the director of the Office of Management and Budget (OMB) and the Secretary of
the Treasury
Trioka--forecasts economic trends, analyzing economic issues, and help to prepare
economic reports; prepares estimates expected to be sent by federal agencies, negotiate
with other departments over the size of the budgets, ensure that legislative proposals are
consistent with the president’s program; provides estimates of revenue based on existing
taxes, represents the US in its dealings with top bankers and finance ministers of other
nations. (RESPECTIVELY)
The Fed
The Board of Governors of the Federal Reserve System--seven members appointed by
the president, with the consent of the Senate, for 14 year, nonrenewable terms and may
not be removed except for cause. Its most important function is to regulate the supply of
money (in circulation and in bank deposits) and the price of money (in the form of
interest rates). Chairmen serve 4 year terms, Alan Greenspan was initially appointed by
Reagan in 1987, Clinton reappointed him largely because of his success in curbing
inflation. see box 467
Congress
The most important part of the economic policy making machinery is Congress. It must
approve all taxes and almost all expenditures
**No matter what economic theory the president may have to look to many agencies, the
Fed, and Congress
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.
Congressional Budget Act of 1974 the president submits his budget in February. Two
budget committees--the House and Senate. Each committee then submits to it house a
budget resolution that proposes a total budget ceiling and a ceiling for each of several
spending areas (such as defense or health).
Entitlements include Social Security and Medicare payments, veterans’ benefits, food
stamps, and money the government owes investors who have bought Treasury bonds
(that is, the interest on the national debt).
Sequester a provision in the bill (Gramm Rudman Act- designed to Balanced Budget of
1985) that required across the board percentage cuts in all federal programs in the
president and Congress failed to agree on a total spending level that met the law’s target.
p. 474 Federal Taxes on income graph
p.475 Federal Income Tax Policy box
The Savings and Loan Mess
Created to help the average person purchase a home.
S&L offered depositors relatively low interest rates and when other financial institutions
(certificates of deposits and money market funds) offered higher rates people took money
out of S&L were allowed to pay. S&Ls were losing money and so they went to Congress
for help. They received the assistance and were allowed to pay higher interest in order to
attract deposits.
The immediate problem was the S&L received 6 percent from the low-interest days of the
1950s and 1960s. When the 9 percent or 10 percent interest, it started to lose money.
The S&L returned to Congress and asked for permission to invest in things that would
earn them a higher return than a home mortage. Congress granted permission and S&Ls
begin investing in shopping malls, farmland, and high yield junk bonds. S&Ls began
investing in high risk deals deals that would pay off handsomely if they worked out but
would cause big losses if they didn’t. Many didn’t. Savings and Loans were not worried
because the government had promised to pay off these depositors if anything went wrong.
In effect, the S&Ls were playing with free money.
In the early 1980s, many S&Ls went bankrupt--they couldn’t earn enough money from
their loans to pay what they owed their depositors. So the federal government had to bail
them out paying off depositors.
Many S&Ls made big contributions to politicians to get them to persuade federal
regulators not to declare S&Ls bankrupt/busted/ruined.
In 1989 Congress passed a law to bail out the system by paying $50 billion to close
insolvent institutions and pay off the depositors. The law also reorganized and tightened
federal regulation of the thrifts. Problems persisted and may cost each taxpayer up to
$2000.
Economic Theories
Presidents rely on economic advisers who generally
accept one of the following:
I. Monetarism--the belief that inflation occurs when
there is too much money chasing too few goods. When
the federal government creates too much money,
inflation occurs. When inflation becomes rampant the
government tries to cut back on the amount of money in
circulation. Then a recession will occur--slowed
economic growth and an increase in unemployment.
Monetarism suggests that government is responsible for
economic problems with its start and stop habit of
issuing new money. Therefore supporters of this policy
recommend a steady, predictable increase in the money
supply at a rate about equal to the growth in the
economy’s productivity; then leave matters alone.
(Milton Friedman)
II. Keynesianism
The health of the market depends on what fraction of
people’s incomes they save or spend. If people save too
much, demand and then production decreases,
unemployment will rise as a result. If they spend too
much, demand will rise too fast, prices will go up, and
shortages will develop. The key is to create the right
level of demand. This is the task of the government.
When demand is too little, government should pump
more money into the economy by spending more than it
takes it in taxes. When demand is too great, the
government should take money out of the economy by
increasing taxes or cutting expenditures. The
performance of the economy is paramount/most
important but Keynesians tend to favor an activist
government.
(John Maynard Keynes)
III. Planning
The government should plan some part of the country’s
economic activity. Economic planning is price and
wage controls. Big corporations can raise prices
because the forces of competition are too weak to
restrain them, and labor unions can force up wages
because management finds it easy to pass the increases
along to consumers in the form of higher prices. Thus
during inflationary times the government should
regulate the maximum prices that can be charged and
wages that can be paid, at least in the larger industries.
(John Kenneth Galbraith)
IV. Industrial Policy The government should somehow
direct or plan investments so that either these industries
would recover or new and better industries would take
their place. (Robert Reich)
V. Supply-Side Tax Cuts
Supporters believe that the market has not been given
an adequate chance. Supply-Side theory--less
government interference in needed. For example,
sharply cutting taxes will increase the incentive to work,
save and invest. Greater investments would led to more
jobs. More workers lead to more taxable income that
adds to an increase in national income.
(Arthur Laffer and Paul Craig Roberts)
Socialist
Liberal
Conservative
Economic planning
Keynesian
Monetarism
Supply-side
GUIDED READING: ECONOMIC AND REGULATORY POLICY
1. Recessions take place when the economy actually shrinks for at least
_____months.
2. ______________ refers to a sustained rise in the general price level of goods
and services.
3. Full employment
4. During the Great Depression, unemployment peaked at over ________ percent.
5. The Great Depression ended majority support for
___________________economics.
6. Among the unemployed, ________ are eligible for unemployment benefits.
7. Today's dollar is worth about how much relative to a dollar of a century ago?
8. The _______ is a measure of the change in price over time of a specific group
of goods and services used by the average household.
9. By the mid-2000s, ______________was increasing at a rate of 3 to 4 percent a
year.
10. The business cycle may be misnamed, because modern "__________" and
"_________" vary greatly in length.
11. John Maynard Keynes is associated with _____________ policy.
12. Fiscal policy:
13. Fiscal policy theory says that when the economy enters a recession, the
government should ________________.
14. Fiscal policy theory says that when the economy is faced with inflation, the
government should_______________________________________.
15. The first president to openly adopt Keynesian economics was ____________.
16. The policies advocated by which two presidents resulted in significant fiscal
policy failures?
17. President Nixon sought to fight inflation by ___________________________.
18. The ___________ _________ debt is defined as the total amount owed by the
federal government to individuals, businesses and foreigners.
19. Gross public debt:
20. The gross domestic product (GDP)
21. Compared to the size of the _____, the net public debt peaked during World
War II.
22. The only president of recent times to actually run a budget surplus, as
opposed to a deficit, was _______________________.
23.
The predictions of experts in the late twentieth century that we would be
running budget surpluses for years to come proved to be as inaccurate as they
were optimistic. Deficit spending became a reality once again by the middle of the
first decade of the twenty-first century. How can this be explained?
24. Monetary policy:
25. What is the responsibility of the Federal Open Market Committee?
26.
____________ policy that makes credit expensive in an effort to slow the
economy may be used in an effort to control inflation.
27. Monetary policy theory says that when the economy enters a recession, the
government should _______________ the rate of growth of the money supply.
28. Monetary policy theory says that when the economy is faced with inflation, the
government should ________________ the rate of growth of the money supply.
29.
The Fed's greatest blunder occurred during the _______________________.
30.
_____________ policy may have limited power to end a recession because
people may be unwilling to borrow even if interest rates fall to zero.
31.
In a Gallup poll conducted in 2006, it was revealed that ___ of Americans
believed that trade between the United States and other countries hurt U.S.
workers.
32. While the American public is skeptical of the benefits of _______________
trade, most economists believe that it benefits the U.S. economy greatly.
33.
Today, imports make up about _____ percent of the goods and services
that we buy in the United States.
34.
The United States exports about ___ percent of the gross domestic
product.
35. Since 1950, world trade has increased by more than twenty times.
36. In the long run, imports are paid for by ______________.
37. __________ are taxes on imports.
38.
____________ created a free-trade zone between the United States and
Canada and Mexico.
39. Describe the World Trade Organization:
40. Because the United States imports more goods and services than it exports,
the _____________________________ and the current account balance are
negative.
41. Because the United States imports more than it exports, foreigners make up
the difference by investing funds in America.
42.
In the last twenty years the United States has enjoyed a larger share of the
world's economic growth than any country other than _________________.
43. The total of all taxes collected by the various levels of government in the
United States is about___________ percent of the gross domestic product.
44. Tax loopholes allow individuals and corporations to reduce their taxable
income legally.
45. With a progressive tax people with higher incomes pay taxes at a higher
percentage rate.
46. What taxes are considered to be generally progressive in their effect?
47. ________________________ is a pay-as-you-go system where those currently
working support those who are retired.
48. Today, _____workers provide for each retiree's benefits, as compared with 42
in 1946.
49. What are the possible solutions advanced by our political leaders to help
ensure Social Security's solvency in the future?
50.
If the government sought to balance the budget by raising taxes on
individuals, the tax rates paid by _________ would have to rise dramatically.
51. "_______________" restrictions on Japanese car imports by one calculation,
cost consumers about $250,000 per year for each job saved.
52.
Although hundreds of thousands of jobs are ____________________ to
other nations, this loss represents a small percentage when it is considered that
the U.S. labor market is close to 140 million people.
53. ___________________ of Social Security means allowing workers to invest part
or all of their Social Security taxes in the stock market.
ESSAY
54.
Explain the circumstances that would arise if the federal government was
required to balance its budget.
ANS: Students' answers may vary.
REF: What If The Federal Government Was Required to Balance Its Budget?
55.
How has the government attempted to address the problem of unemployment?
ANS: Students' answers may vary.
56.
Explain the impact of Keynesian Economics on fiscal policy in the United States.
What were the most impressive instances of Keynesian Economics at work in our
government? What were the most disastrous?
ANS: Students' answers may vary.
57.
Explain how the United States went from having a budget surplus at the end of
the Clinton Administration to shouldering a $300 billion deficit for 2006.
ANS: Students' answer may vary.
58.
Explain the difference between loose and tight monetary policy and when they
would be appropriate policy options.
ANS: Students' answers may vary.
59.
Contrast the views of economists and the American people on the issue of world
trade.
ANS: Students' answers may vary.
60.
Explain the costs associated with governmental action to protect American jobs
and whether those costs outweigh the benefits.
ANS: Students' answers may vary.
REF: Politics and Trade—The High Cost of Saving U.S. Jobs
61.
Explain the role of the World Trade Organization and whether the United States
should attempt to play a major role in its operation.
ANS: Students' answers may vary.
62.
Is outsourcing of American jobs really the problem that so many politicians make
it out to be?
ANS: Students' answers may vary.
REF: Sending Work Overseas
63.
Explain the difference between progressive and regressive taxes. Would we be
better served by simply employing a flat tax across the board?
ANS: Students' answers may vary.
64. Explain the theory behind the creation of Social Security, the problems that arise
from its operation and possible solutions to save it.
ANS: Students' answers may vary.
Defense Spending
The ARRA will add an extra $7.03 billion to the defense budget with about $4.2
billion set aside to modernize and repair facilities. There will be $1.3 billion for
military family medical care. Billions more will be spent on everything from housing
to National Guard facilities.
Education
The majority of the education spending, around $15.6 billion, will go towards the Pell
Grant Program. There is $13 billion set aside for low-income school children and
$12.2 billion for special education. There is also money for childcare and Head Start.
Health Care
The ARRA act sets aside $19 billion for health care information technology and
another $2 billion for Community Health Centers. There is $500 billion appropriated
for training health care professionals like nurses.
Social Spending
Appropriations include $4 billion to modernize public housing, $19.9 billion for Food
Stamps and $3.95 billion for job training. Social Service spending will be at least $38
billion. See Housing, Hunger and Job Assistance below.
Research
There is at least $17 billion in the bill for research spending. There is money
available for research into health ailments, NASA and Energy. There is $1.3 billion
set aside to upgrade the university research centers around the country.
Transportation Projects
There is at least $48 billion in transportation projects in the bill. $27.5 will go
towards highway and bridge construction. Local governments will get $1.5 billion for
roads. There is $1.3 billion for Amtrak and another $750 million for new rail
construction. See the complete list below.
By Dan Wilson
American Recovery and Reinvestment Act of 2009
Defense Spending
Repair and modernize Department of Defense facilities
Medical care for service members and their families
Improve housing for service members
New child development centers
Construction of state extended-care facilities
Increase of claims processing staff
Improve facilities of the National Guard
$4.2 billion
$1.3 billion
$890 million
$240 million
$150 million
$150 million
$100 million
Schools
Increase Pell Grants by $500 to $5,350
Low-income public schoolchildren
IDEA special education
Head Start
Childcare services
Educational technology
Increased teacher salaries
States to analyze student performance
Support working college students
Education of homeless children
$15.6 billion
$13 billion
$12.2 billion
$2.1 billion
$2 billion
$650 million
$300 million
$250 million
$200 million
$70 million
Energy
Funding for an electric smart grid
$11 billion
State and local governments to make investments in energy efficiency $6.3 billion
Renewable energy power generation loans
$6 billion
Weatherizing modest-income homes
$5 billion
State and local governments to increase energy efficiency in federal
$4.5 billion
buildings
Carbon capture experiments
$3.4 billion
Energy efficiency research
$2.5 billion
Car battery research
$2 billion
Training of green-collar workers
$500 million
Electric vehicle technologies
Buy energy efficient appliances
Reducing diesel fuel emissions
State and local governments to purchase energy efficient vehicles
Increase energy efficiency in low-income housing
$400
$300
$300
$300
$250
Environmental cleanup
Cleanup of radioactive waste
Cleanup hazardous waste that threaten health and the environment
Cleanup petroleum leaks from underground storage tanks
Evaluate and cleanup brownfield land
$6 billion
$600 million
$200 million
$100 million
Government technology improvements
Computer center at the Social Security Administration
Upgrade IT platforms at the State Department
IT improvements at the Farm Service Agency
Improve security systems at the Department of Agriculture
headquarters
million
million
million
million
million
$500 million
$290 million
$50 million
$24 million
Healthcare
health information technology
Community Health Centers
Effectiveness of certain healthcare treatments
Fight preventable chronic diseases
Train healthcare personnel
Healthcare services on indian reservations
$19 billion
$2 billion
$1.1 billion
$1 billion
$500 million
$500 million
Housing
Repairing and modernizing public housing
Tax credits for financing low-income housing construction
Section 8 housing rental assistance
Communities purchase and repair foreclosed housing
Rental assistance and housing relocation
Rehabilitation of Native American housing
Helping rural Americans buy homes
Rural community facilities
Help remove lead paint from public housing
$4 billion
$2.25 billion
$2 billion
$2 billion
$1.5 billion
$510 million
$200 million
$130 million
$100 million
Hunger assistance
Food Stamp Program
Help refill food banks
Meals programs for seniors, such as Meals on Wheels
Free school lunch programs
$19.9 billion
$150 million
$100 million
$100 million
Job assistance
Job training
Vocational training for the disabled
Employment services
Subsidized community service jobs for older Americans
$3.95 billion
$500 million
$400 million
$120 million
Scientific research
National Institutes of Health
National Science Foundation
United States Department of Energy
University research facilities
NASA
National Oceanic and Atmospheric Administration (NOAA)
National Institute of Standards and Technology
NOAA operations, research and facilities
United States Geological Survey
$8.7 billion
$3 billion
$2 billion
$1.3 billion
$1 billion
$600 million
$580 million
$230 million
$140 million
Transportation projects
Highway and bridge construction projects
High-speed rail projects
New equipment for public transportation projects
Competitive grants to state and local governments for transportation
investments
Amtrak
Improving airport security
Construction of new public rail transportation systems
Maintenance of existing public transportation systems
Improving security at the border and ports of entry
Maintenance of United States Coast Guard facilities
$27.5 billion
$8 billion
$6.9 billion
$1.5 billion
$1.3 billion
$1.1 billion
$750 million
$750 million
$720 million
$240 million
Veterans Affairs facilities
Veterans Health Administration
National Cemetery Administration
$1 billion
$50 million
Telecommunications
Complete broadband and wireless Internet access
DTV conversion coupons
$7.2 billion
$650 million
Aggregate demand
Also more accurately referred to as aggregate expenditure, this is one of the key
concepts introduced by John Maynard Keynes that still today is at the heart of
most macroeconomic theories about the determination of the overall level of
employment (and thus the level of national income produced) in a country's
economy during a given year. Although there have turned out to be a number of
logical problems and ambiguities in making the analogy work, Keynes's original
basic notion was that “aggregate demand” represented a sort of grand total or
summarization of all the various demand schedules for all the millions of different
goods and services produced in a country's national economy. Thus, Keynes
reasoned, just as the microeconomic theorist can fruitfully analyze the
relationship between the various quantities of a particular good or service that will
be purchased by consumers at various prices on a single market by means of a
demand schedule or demand curve, the macroeconomic theorist can make
similarly good use of an aggregate demand schedule or aggregate demand curve
as a means for analyzing the relationship between the various possible grand
totals of all goods and services purchased in the national economy (as measured
by their total monetary value in the form of a national product estimate like GNP
or GDP) and the general price level (as measured by some sort of comprehensive
price index rather like those whose yearly rates of change are commonly used to
measure inflation). Once he had the brainstorm that one could sum up all the
demand schedules for individual goods into a single grand total “aggregate
demand schedule,” it was not much of a mental leap for Keynes to conclude that it
might be useful first to divide up aggregate demand into a small number of
“subtotal” aggregate demand schedules whose interrelationships might help
explain such large-scale macroeconomic phenomena as the business cycle,
inflation, economic growth and the like. Thus Keynes invented most of the basic
ideas of what is today the macroeconomists' conventional system of national
income accounting when he formulated his famous aggregate demand identity
Y = C + I + G + (X - M)
which simply means that a single country's aggregate demand for national product
(Y) is always equal to the total demands of its households for Consumer goods
and services (C), plus the total demands of its firms for Investment goods (I), plus
the total demands of its various Government agencies for goods and services (G),
plus the net demands of foreign consumers, firms and governments for the
country's goods and services (exports minus imports).
Aggregate supply
Another of the concepts introduced by John Maynard Keynes that still today are
used in macroeconomic theories about the determination of the overall level of
employment and national income. Like his concept of aggregate demand, the
basic notion of aggregate supply was created by analogy to a microeconomic
concept originally applying only to an analysis of the market for a single product
— in this case, the concept of a supply schedule. Thus, Keynes reasoned, just as
the microeconomic theorist can fruitfully analyze the relationship between the
various quantities of a particular good or service that will be produced and offered
for sale by firms at various prices on a single market by means of a supply
schedule or supply curve, the macroeconomic theorist can make similarly good
use of an aggregate supply schedule or aggregate supply curve to depict the
relationship between the various possible grand totals of all goods and services
produced and offered for sale in the national economy (as measured by their total
monetary value in the form of a national product estimate like GNP or GDP) and
the general price level (as measured by some sort of comprehensive price index
rather like those whose yearly rates of change are commonly used to measure
inflation).
Allocation
The division of things into shares or portions. In economics, the term refers
primarily to the “allocation of resources,” the process by which economic
resources get allotted (apportioned, assigned) to their particular uses for directly
or indirectly satisfying human wants. The allocation process in a particular
society's economy is the process by which the three fundamental economic
questions get answered in that society:
1. What goods and services are produced (and in what quantities)?
2. By which of the various available technological means and recipes are
each of these goods and services to be produced from the available land,
labor and capital?
3. For whom are each of these goods and services produced? (Which specific
individuals get to use/consume each unit of each good or service
produced?)
Thus one may speak of “market allocation” of resources, “forcible allocation” of
resources, “governmental allocation” of resources, “traditional” (or “customary”)
allocation of resources and so on, depending upon the kinds of social processes
and incentives by which various sorts of scarce resources are allocated in the
particular society under consideration.
Appropriation bill
A (proposed) formal action by a legislative assembly (such as the U.S. Congress
or a state legislature) that specifies exact amounts of the government's money that
the Treasury may legally pay out (through new hiring, contracts for purchases,
findings of individuals' eligibility for income transfer payments, etc.) for each of a
list of particular pre-authorized programs carried out by governmental agencies
over a specific period of time (normally one year).
Authorization bill
A (proposed) formal act (or “law”) of a legislative body (such as the U.S.
Congress or a state legislature) that legally establishes a new government agency
or program or else renews or extends an existing agency or program whose
previous legal authorization to exist would otherwise expire with the passage of
time. Authorizations may be for one year or more than one year — about one-half
of current Federal spending is by agencies or programs subject to annual reauthorization, while the other half gets its legal basis either from longer term
authorization bills or from permanent laws that provide spending authority
automatically to ongoing entitlement programs like Social Security. Authorization
bills also include specific figures as funding levels for the agencies and programs,
but these sums are upper limits only (for the guidance of the appropriations
committee) — no money can actually be spent or committed by the agency or
program administrators until after a separate appropriation bill has also been
passed and signed into law, legally enabling the Treasury to disburse the money.
The amount of money eventually appropriated for an agency or program is most
often less than the amount previously authorized, so an authorization bill is rather
like a necessary “hunting license” for an appropriation rather than a guarantee. No
appropriation can be made for an unauthorized program, but even an authorized
program may still die or be unable to perform all its assigned functions for lack of
a sufficiently large appropriation of funds. This often happens in the decentralized
American political system, because authorization bills are each drafted by one of
the many specialized standing committees in Congress (the Agriculture
Committee, the Armed Forces Committee, etc. — who tend to be cheerleaders for
“their” pet agencies), while appropriation bills are drafted by the different set of
lawmakers who serve on the specialized subcommittees of the Appropriations
committees in the two chambers (who still have to get their funding choices
through the full Appropriations committee, which is responsible for weighing the
relative merits and urgency of all the different programs against each other before
dividing up the budget pie).
Banking
In the broadest sense of the term, “banking” is the business of accepting
temporary responsibility for safeguarding other people's money (“deposits”) and
then lending out these funds (along with the bankers' own funds) in order to earn
interest for the bank's own account. Banking firms thus earn their profits primarily
by serving as “financial intermediaries” who mobilize the scattered savings of
many households and firms (by offering safekeeping services and paying interest
on at least some kinds of accounts) and then make these pooled funds available to
suitable borrowers (to business firms that want to finance proposed investment
projects or perhaps to consumers who want to finance big ticket durable
consumers' goods like automobiles or perhaps to governmental entities whose
policy-makers have decided to spend more money than they have received in
revenue collections). The bank pledges its own capital (and also buys outside
deposit insurance) to guarantee that any depositor can get all his/her money back
in cash no later than some contractually specified length of time after giving
notice of withdrawal. The bank makes this somewhat risky guarantee even though
it is quite predictable that some (hopefully small) percentage of the loans the
bankers make using depositers' funds will “turn sour” and not be repaid by the
borrower. The bank's profits arise mainly from the (positive) spread between its
costs of securing and servicing deposits and its revenues from fees and interest on
the loans extended. (Of course banks frequently seek to make additional profits
selling other financial services to their clients and customers as well, but the
business of accepting deposits and making loans is the defining core of the
banking business.)
Not all firms engaging in “banking” in this broad sense are officially called
“banks.” Savings and loan associations, credit unions and other miscellaneous
thrift institutions provide similar services under other names. The laws of the
United States and most other developed industrial countries provide for multiple
types of financial intermediary institutions whose official “labels” normally
depend upon the selected purposes for which they will loan money (business
loans, consumer loans, real estate mortgages, etc.), the maximum time period for
which they will contract a loan (2 years? 5 years? 30 years?), and the kinds of
supplementary services (checking privileges, foreign exchange, management of
trusts and estates, etc.) that they may provide for their customers beyond basic
taking of deposits and extension of loans.
From the perspective of this course, banks are mainly of interest because of their
key role in determining the size of the money stock. Considerably less than half of
the US money stock (M1) consists of physical cash or currency (coins and bills).
Most of the money stock in the US (or any other present-day advanced industrial
economy) is in the form of “mere” ledger entries representing bank depositers'
credit balances in their individual or corporate checking accounts. And, amazingly
enough to the uninitiated, this means that banks are constantly creating money
“out of thin air” simply by making bookkeeping entries that assign new checking
account credits to customers as they take out loans from the bank.
Of course, private banks cannot simply create money out of thin air without limit
and still expect to stay in business. When the bank credits a borrower's account
with the amount of his new loan, it is to be expected that the borrower will very
soon want to spend part or all of the money he has borrowed. After the check the
borrower writes is deposited in somebody else's account in another bank, the
check will soon be presented for collection at the lending bank, and they will have
to have the cash on hand to pay the other bank off at that time. The more dollars'
worth of loans a bank has extended, the more cash it will have to have on hand in
reserves to meet the daily flow of redemptions. Most or all of the check
redemption demands coming in every day can normally be offset by the cash and
checks drawn on other banks that the depositers and borrowers have brought in
and deposited or paid that day, but an “unsound” bank that extends loans with
reckless abandon sooner or later will find that the flow of checks presented to it
for collection greatly exceeds the flow of outside checks and cash being brought
in. Once the bank's vaults are empty and the cash reserves are gone, the
management must quickly (overnight!) either borrow the necessary additional
cash elsewhere (probably at high interest rates) or else sell off some of the bank's
assets (because of the haste, probably at fire-sale prices). When the troubled bank
can no longer borrow and has no assets left that can be sold on short notice, it can
no longer fulfill its ontractual guarantees to pay its obligations on demand and is
therefore out of business with the banks owners and managers now subject to civil
(and perhaps criminal) legal penalties (bankrupcy, suits for breach of contract,
negligence, and fraud, indictments for fraud, embezzlement, etc.).
“Sound” banks limit the volume of the loans they extend so that they remain in a
prudent proportional relationship to the amount of instantly liquid funds they have
available in “reserves” (either as currency in the vault or as demand deposits in
some other bank, such as the Federal Reserve). But bankers face a difficult tradeoff. The flow of checks that will be presented for payment and the volume of new
deposits and loan repayments coming in every day cannot be predicted with 100%
accuracy, so the higher the fraction of its total deposit obligations the bank holds
ready in reserves, the safer or “sounder” the bank can be considered (and the more
attractive the bank will seem to depositers and other potential business
associates). However, reserves do not yield any interest income to the bank; only
the funds that are tied up in loans to (solvent) borrowers can contribute directly
and immediately to the bank's profitability. To maximize their profits, bank
management must find the best way to strike a balance between the need to
maintain their “reserve ratio” at a level high enough to limit their risks of
becoming insolvent and the conflicting need to keep the highest feasible
proportion of the bank's available funds loaned out at interest.
Budget
A statement of a government's planned or expected financial position for a
specified period of time (usually one year) based on estimates of the expenditures
to be made by the government's main subdivisions (wages and salaries of
government employees; consultants' fees; purchases of equipment, supplies, real
estate, etc.; money transferred to beneficiaries of various programs, and so on)
during the specified period, along with estimates of the revenues to be realized
from the various sources of income that will be available for paying for these
expenditures. The budget of a government may be seen as a comprehensive plan
of what the government will spend for its various programs during the next fiscal
year and how it expects to raise the money to pay for them (tax receipts, charges
for services, sale of assets, borrowing, new emissions of currency, etc.) Somewhat
confusingly, the same term is used to denote both the advance estimate or plan of
what the government will be taking in and spending and also the actual amounts
that finally end up being taken in and spent — even though the planned and actual
numbers never really match perfectly when the returns come in!
Budget deficit
The amount by which total government spending is more than government
income during a specified period; the amount of money which the government has
to raise by borrowing or currency emission in order to make up for the shortfall in
tax revenues.
Budget surplus
The amount by which government revenues are more than government spending
during a specified period.
National debt
As usually defined, this denotes the total sum of the outstanding debt obligations
of a country's central government. (But occasionally writers may use the term
somewhat more broadly to refer to the total indebtedness of all levels of
government, including regional and local governments, and sometimes also the
indebtedness of government owned business entities such as local transit and
communications systems or nationalized industries as well.) The national debt
represents the accumulated total of all the government budget deficits of past
years, less the accumulated total of all the government budget surpluses of past
years. For most developed countries, such as the United States, the national debt
consists almost entirely of interest-bearing "IOU" instruments that are usually resellable on organized financial markets (such as, for example, U.S. bonds, U.S.
treasury notes, and U.S. treasury bills). These IOUs are originally purchased from
the Treasury by private individuals, private corporations, insurance companies,
pension funds and banks (both inside the United States and outside its borders),
and the Treasury then uses the money thus raised to bridge its spending gap when
its budget is in deficit. (The Treasury also sells IOUs to other Federal agencies
that operate so-called trust funds -- primarily the Social Security Administration
and other Federal retirement programs -- but since this is money that the
government "owes to itself," it is not counted as part of the national debt in any
realistic system of accounting.) Money to pay the annual interest owed to the
owners of the government's debt instruments has to be provided through
appropriations in every year's Federal budget and, indeed, these interest payments
on the national debt nowadays always constitute one of the two or three largest
spending categories in the budget.
Monetary policy
That part of the government's economic policy which tries to control the size of
the total stock of money (and other highly liquid financial assets that are close
substitutes for money) available in the national economy in order to achieve
policy objectives that are often partly contradictory: controlling the rate of
increase in the general price level (inflation), speeding up or slowing the overall
rate of economic growth (mainly by affecting the interest rates that constitute such
a large share of suppliers' costs for new investment but partly by influencing
consumer demand through the availability of consumer credit and mortgage
money), managing the level of unemployment (stimulating or retarding total
demand for goods and services by manipulating the amount of money in the
hands of consumers and investors), or influencing the exchange rates at which the
national currency trades for other foreign currencies (mainly by pushing domestic
interest rates above or below foreign interest rates in order to attract or discourage
foreign savings from entering or leaving domestic financial markets). Monetary
policy is said to be "easy," "loose," or "expansionary" when the quantity of money
in circulation is being rapidly increased and short-term interest rates are thus
being pushed down. Monetary policy is said to be "tight" or "contractionary"
when the quantity of money available is being reduced (or else allowed to grow
only at a slower rate than in the recent past) and short-term interest rates are
thus being pushed to higher levels.
The government's ability to control the size of the money stock and the levels of
interest rates is only partial, not absolute. This is because monetary policy makers
must rely mainly on influencing the privately-owned banking system's supply
schedule for loaned funds. Monetary policy makers are much less able to affect
the private sector's demand schedule for such funds, yet both supply and demand
for money interact to determine the quantity of money created and its price, the
interest rate. Even in trying to control the supply side of the loan market, it is
easier for the Fed to force the banks to tighten credit and make fewer new loans
(by raising the legal reserve requirements, for example) than it is to convince
them to extend a larger volume of loans when bankers have become worried
about their prospects for being repaid (or fear rapid inflation will cause their
repayments to be worth less than the original value of the their loans).
Government monetary policy-makers are generally much more successful in
manipulating short-term interest rates (rates on loans for periods of less than a
year) than they are in manipulating medium-term interest rates (1 to 5 years) and
long-term interest rates (more than five years). This is because demand and
supply for medium-term and long-term loans tend to be both much more elastic
and much more affected by the public's expectations about future rates of inflation
than the supply and demand for short-term loans are. A very expansionary
monetary policy may well lower short-term interest rates by flooding the banks
and financial markets with loanable funds and yet at the same time may actually
raise longer-term interest rates by prompting fears among lenders that inflation
will soon be accelerating. Unfortunately, medium and long-term interest rates
have much more influence on the rate of growth of the economy and on levels of
unemployment than short-term interest rates do, because major new investment
spending like research and development for new products or the construction of
whole new factories are long-term projects that require long-term financing, and
they are much less likely to be undertaken if long-term interest costs are high than
if they are low.
Capital
The existing stock of goods which are to be used in the production of other goods
or services and which have themselves been produced by previous human
activities. Capital is conventionally subdivided into "fixed capital" and
"circulating capital," although the distinction is mainly a matter of degree of
durability rather than a clear-cut difference in kind. Fixed capital refers to durable
producers' goods such as buildings, plant and machinery, while circulating capital
refers to stockpiles of materials, semi-finished goods, and components that are
normally used up very rapidly in production. Notice that "capital" in the strictest
economic sense refers only to real, physical means of production already in being,
not to the sums of money put aside through savings to purchase real capital with
in the future (although the total amount of capital in a particular firm may for
convenience be described or summarized in monetary terms by the potential
resale values of all the separate items of capital added together in one grand sum).
Capital
The existing stock of goods which are to be used in the production of other goods
or services and which have themselves been produced by previous human
activities. Capital is conventionally subdivided into "fixed capital" and
"circulating capital," although the distinction is mainly a matter of degree of
durability rather than a clear-cut difference in kind. Fixed capital refers to durable
producers' goods such as buildings, plant and machinery, while circulating capital
refers to stockpiles of materials, semi-finished goods, and components that are
normally used up very rapidly in production. Notice that "capital" in the strictest
economic sense refers only to real, physical means of production already in being,
not to the sums of money put aside through savings to purchase real capital with
in the future (although the total amount of capital in a particular firm may for
convenience be described or summarized in monetary terms by the potential
resale values of all the separate items of capital added together in one grand sum).
Capitalism
A form of economic order characterized by private ownership of the means of
production and the freedom of private owners to use, buy and sell their property
or services on the market at voluntarily agreed prices and terms, with only
minimal interference with such transactions by the state or other authoritative
third parties.
Commerce clause
The provision of the U.S. Constitution (Article I, Section 8, paragraph 3) that
gives Congress the authority to regulate trade with foreign nations and among the
states.
Communism
1. Any ideology based on the communal ownership of all property and a
classless social structure, with economic production and distribution to be
directed and regulated by means of an authoritative economic plan that
supposedly embodies the interests of the community as a whole. Karl
Marx is today the most famous early theoretician of communism, but he
did not invent the term or the basic social ideals, which he mostly
borrowed and adapted from the less systematic theories of earlier French
utopian socialists -- grafting these onto a philosophical framework Marx
derived from the German philosophers Hegel and Feuerbach, while adding
in a number of economic theories derived from his reinterpretation of the
writings of such early political economists such as Adam Smith, Thomas
Malthus, and David Ricardo. In most versions of the communist utopia,
everyone would be expected to co-operate enthusiastically in the process
of production, but the individual citizen's equal rights of access to
consumer goods would be completely unaffected by his/her own
individual contribution to production -- hence Karl Marx's famous slogan
"From each according to his ability; to each according to his need." The
Marxian and other 19th century communist utopias also were expected to
dispense with such "relics of the past" as trading, money, prices, wages,
profits, interest, land-rent, calculations of profit and loss, contracts,
banking, insurance, lawsuits, etc. It was expected that such a radical
reordering of the economic sphere of life would also more or less rapidly
lead to the elimination of all other major social problems such as class
conflict, political oppression, racial discrimination, the inequality of the
sexes, religious bigotry, and cultural backwardness -- as well as put an end
to such more "psychological" forms of suffering as alienation, anomie, and
feelings of powerlessness.
2. The specifically Marxist-Leninist variant of socialism which emphasizes
that a truly communist society can be achieved only through the violent
overthrow of capitalism and the establishment of a "dictatorship of the
proletariat" that is to prepare the way for the future idealized society of
communism under the authoritarian guidance of a hierarchical and
disciplined Communist Party.
3. A world-wide revolutionary political movement inspired by the October
Revolution (Red Oktober) in Russia in 1917 and advocating the
establishment everywhere of political, economic, and social institutions
and policies modeled on those of the Soviet Union (or, in some later
versions, China or Albania) as a means for eventually attaining a
communist society.
Socialism
A class of ideologies favoring an economic system in which all or most
productive resources are the property of the government, in which the production
and distribution of goods and services are administered primarily by the
government rather than by private enterprise, and in which any remaining private
production and distribution (socialists differ on how much of this is tolerable) is
heavily regulated by the government rather than by market processes. Both
democratic and non-democratic socialists insist that the government they envision
as running the economy must in principle be one that truly reflects the will of the
masses of the population (or at least their "true" best interests), but of course they
differ considerably in their ideas about what sorts of political institutions and
practices are required to ensure this will be so. In practice, socialist economic
principles may be combined with an extremely wide range of attitudes toward
personal freedom, civil liberties, mass political participation, bureaucracy and
political competition, ranging from Western European democratic socialism to the
more authoritarian socialisms of many third world regimes to the totalitarian
excesses of Soviet-style socialism or communism.
Business cycle
More or less regular swings or wave-like fluctuations in the pace of a country's
economic growth, well above and well below the long-term trend in the growth
rate of total production; the ups and downs of overall business activity, as
evidenced by surges and declines in GNP and GDP, unemployment rates, and the
general price level; the boom-and-bust pattern of recession (or depression) and
recovery. In older economic literature (and still today in British usage) the term
“trade cycle” is often used as a synonym for “business cycle.”
What causes business cycles has been one of the hottest and longest running
theoretical debates in political economy. There is a fair amount of agreement on
what at least some of the factors are that are associated with the alternation of
economic booms and busts, but different schools of thought differ considerably in
the relative weight and the causal priority they assign to these various factors.
Some schools of thought emphasize uneven government economic policies as the
principal cause of business cycles, while others see government economic policies
as the key influences working to even out business cycles allegedly brought on by
inherent features of the market economy.
Nearly all of these competing theories key in on one or more of the factors
believed to influence the expansion and contraction of total saving by the public
and of new capital investment undertaken by business firms as the most
immediate causes of booms and busts in the larger economy.
John Maynard Keynes's explanation of the business cycle emphasized periodic
shifts in the public's allocation of their incomes between current spending for
immediate consumption and savings for future consumption — which leads to
shifts in the overall level of demand for consumers' goods, which in turn
encourages producers of consumers' goods disproportionately to expand or
contract their own purchases of producers's goods like raw materials and
machinery (and labor) more or less all at once in response to improvements or
declines in their current sales. Keynes believed that the public typically tends to
save too much and consume too little, thereby throttling aggregate (total) demand,
unless the government steps in from time to time through its fiscal policies to
artificially increase aggregate demand by spending more on goods and services
than it takes away from consumers' purchasing power in taxes (“running a budget
deficit”).
Other non-Keynesian theorists of the business cycle have focussed on other (often
psychological) factors besides the growth or decline of their current sales that
influence businessmen's optimism or pessimism about future economic conditions
(and hence their investment plans). Still other theorists emphasize the role of
occasional “supply shocks” — sudden and unexpected changes in the supply of
key resources resulting from weather cycles, natural disasters, international
conflicts, big regulatory or tax changes by government, etc. (For example, the
formation of the OPEC oil producers' cartel and their two massive waves of
concerted production cuts/price increases in the 1970s.) Joseph Schumpeter's
theory of “creative destruction” stresses the role of waves of massive innovation
(major technological breakthroughs, introduction of major new products that
create whole new industries) in precipitating major adjustments and reallocation
of resources as old industries die and are replaced by new ones. “Monetarist”
theories of the business cycle analyze the impact of shifts in decisions of the
government monetary authorities (such as the Board of Governors of the U.S.
Federal Reserve Banking System) to expand or contract the money supply in their
efforts to manipulate short-term interest rates and foreign exchange rates (often
for selfish political reasons). “Supply-side” theorists of the business cycle tend to
emphasize the impact of periodic changes in government tax policies (especially
changes in the marginal rates of taxation on various forms of investment
expenditures and business income) as the major precipitant of booms and busts.
Deflation
The opposite of inflation -- that is, a sustained fall over time in the general level
of prices, normally measured by the annual percentage increases or decreases of a
weighted index of prices of some large and representative sample of goods and
services (both consumers' goods and producers' goods) regularly traded in the
particular economy under consideration. Just as very large scale inflations are
normally the result of large percentage increases in the money stock, large-scale
deflations are normally the consequence of substantial reductions in the available
money stock.
Competition
Competition is one of the most important concepts in economics, yet when
examined closely, it turns out to be one of the most elusive concepts to nail down
in practice. A market in some particular good or service is said by economists to
be "competitive" if a substantial number of buyers and sellers trade in the good or
service independently and thus no single buyer or seller is so "weighty" in the
marketplace as to significantly influence the going price of the good or service by
his/her individual decisions about how many units he personally will buy or sell.
The practical problems (and disagreements) in assessing whether a particular
market is "competitive" or not arise when you look at the real world and try to
specify the geographic boundaries of the market and the breadth or narrowness of
the definition of the good on which you are focussing. Billy-Bob Motors may
have the only Ford dealership in town, giving him a "monopoly" in some very
narrow sense -- but local car buyers will be quick to travel to other Ford
dealerships in any of a number of other cities or towns if Billy-Bob tries to take
advantage of his monopoly by jacking up the price and then word gets around
(perhaps through advertising) that there are noticeable advantages in the deals
offered on Fords elsewhere. The bigger the price differential and the lower the
transportation costs between seemingly distinct market areas, the larger the
effective market area really becomes. Similarly, dealerships in Chevrolets,
Plymouths, Volkswagens, Toyotas, Nissans, Volvos, Fiats, Hyundais, and Hondas
are not selling exactly the same products as Ford dealerships (even Fords come in
various models), but they sell very close substitutes for Fords that many buyers
will turn to if the price of a new Ford at Billy-Bob's seems out of line. Used car
dealers, estate sale auctions, bankruptcy liquidators and ordinary citizens selling
their old cars through newspaper ads provide still other sources of supply for
slightly less close substitutes for a brand new Ford. Even taxis, bus systems, renta-car agencies, subway systems, railroads, tractors, motorcycles, motorscooters,
mopeds, bicycles, roller skates, dog-sleds and "shanks' mare" constitute partial
substitutes for Ford ownership as a method of getting around from point A to
point B and thus have a "competitive" restraining effect on pricing in the local
market for Fords (which may be seen as only a part of some much broader market
in means of personal transportation).
The bottom line -- competitiveness in markets is a matter of degree, and the
observer's assessment of the degree of competitiveness in concrete instances will
be heavily influenced by the observer's initial assumptions about the geographic
extent of the market area and the breadth or narrowness of his definition of the
good or class of goods that constitute equivalent products.
Monopoly
Literally, "single seller." A situation in which a single firm or individual produces
and sells the entire output of some good or service available within a given
market. If there are no close substitutes for the good or service in question, the
monopolist will be able to set both the level of output and the price at such a level
as to maximize profits without worrying about being undercut by competitors (at
least in the short run). If demand for the good or service being sold by the
monopolist is highly inelastic, prices and the rate of profit in the industry will tend
to be higher (and output lower) than under competitive conditions and prices may
in fact be noticeably higher than the marginal costs of production for substantial
periods of time. To keep new competitors from entering the industry and flooding
the market with additional supply in response to the unusually high rate of profit,
monopolists historically have typically had to rely in the long run upon some sort
of legal barriers to entry erected by government -- either an open grant of
protected monopoly that legally forbids competitors to enter the market, or a
regulatory regime that in practice makes it almost impossible for new competitors
to meet required standards, or perhaps only such more transient barriers to entry
as legally protected patent rights or copyrights for essential technology. However,
see also entries under barriers to entry, cartel, natural monopoly and competition.
Demand
The willingness and ability of the people within a market area to purchase
particular amounts of a good or service at a variety of alternative prices during a
specified time period.
Demand, law of
Other things being held constant, the lower the price of a good (or service), the
greater the quantity of it that will be demanded by purchasers at any given time.
Demand curve
A graphical representation of a demand schedule. Conventionally, the demand
curve is usually drawn between axes with price plotted along the vertical axis and
number of units of the good or service demanded plotted along the horizontal
axis. Where the law of demand applies to the particular market under
consideration, the demand curve will slope (either gently or steeply) downwards
from left to right.
Federal Reserve System
The central bank for the United States banking system and the institution that
holds the primary responsibility for the making and execution of American
monetary policies. Its bank notes circulate today as the United States' everyday
paper currency. (Metal coins, however, are issued by the United States Treasury
Department, not by the Federal Reserve.)
The Federal Reserve System represents an almost unique hybrid or blending of
elements of governmental power with elements of private ownership and control.
Because the authors of the 1913 legislation that set up the Federal Reserve System
felt that it was vital to insulate monetary policy from "undue" pressure and
influence by partisan politicians obsessed with their own short-range re-election
prospects, the Federal Reserve was set up along the lines of an independent
regulatory commission -- not as just one more agency of the Executive Branch
that would be under the direction of the President and supervised closely by
Congress. The private banking community was also given a major role in the
running of the Federal Reserve System that continues to give banking interests
privileged access to the process by which the US government's monetary policy is
made.
The Federal Reserve System's highest decision-making body is its Board of
Governors, which consists of seven members. Members of the Fed's Board of
Governors are nominated for their positions by the President of the United States
and then must be confirmed by a majority vote of the Senate before taking office.
The members of the Federal Reserve's Board of Governors serve very long terms
(fourteen years), and, once appointed and confirmed, they may not be removed
from office by either President or Congress (except through a cumbersome
process of impeachment by Congress for serious violations of the criminal law).
People selected for appointment to the Board of Governors have nearly always
been professional bankers, executives of Wall Street brokerage houses, or,
occasionally, professional economists. They tend to share many of the relatively
conservative political and economic views of the business and professional groups
from which they are drawn. Because the President can not fire them from their
positions before their fourteen-year terms expire, members of the Board of
Governors normally feel relatively free to ignore or oppose the President's
preferences when they make U.S. monetary policies. Moreover, even though
some members of the Board of Governors perhaps feel an ideological kinship or
sense of political loyalty that might predispose them to support the policy views
of the President who appointed them, the terms of the Governors are staggered, so
that only one Governor's term expires every two years, making it unlikely that any
President would be able to dominate the Board with a majority of his own
appointees until near the end of his own second four- year term in office.
(However, every four years, the President does at least get the opportunity to
designate which one of the seven Governors will serve for the next four years as
Chairman of the Board of Governors and exercize "moral leadership" as first
among equals in the Governors' collective deliberations on monetary policy.)
Congressional influence on the Federal Reserve System's monetary policy
decisions is also in practice rather limited. The Federal Reserve generates its own
revenues to pay its expenses from fees paid to it by the commercial banks it
regulates and from interest payments on the federal bonds, notes and bills that it
holds as assets, so Congress lacks the normal leverage it has over other agencies
through carrots and sticks brandished during the annual appropriations process.
Of course, Congress, which created the Federal Reserve System by statute in
1913, has the constitutional power to alter or abolish the Federal Reserve system
by a simple majority vote in both houses, subject to the possibility of a
presidential veto, and the threat that Congress might actually do so if the Fed's
policies contradict Congresssional preferences too seriously for too long
undoubtedly induces a certain amount of responsiveness to Congressional jawboning by the Fed's policy-makers.
The Federal Reserve System presided over by the Board of Governors consists
organizationally of 12 separate Federal Reserve District Banks -- each one located
in and serving one of twelve geographical regions of the country. The district
Federal Reserve banks are organized rather like private banking corporations
whose shareholders consist of the private member banks in the district. But
despite their semi-private character, the district Federal Reserve banks exercise
Congressionally delegated legal powers to regulate the banking industry. Each
district Federal Reserve Bank is managed from day to day by its own president,
who is elected to a 5-year term by his district Federal Reserve Bank's own
individual board of directors. Two-thirds of the members of the district boards of
directors are elected to their positions by the privately owned commercial banks
in the district that are member banks of the Federal Reserve system. (Member
banks are divided on the basis of their assets into "small", "medium", and "large"
banks, with each category of banks allowed to elect two directors on a "one bank,
one vote" basis.) The other one- third of the directors in each district are
appointed from Washington by the Fed's Board of Governors, rather as though the
Board of Governers were a major creditor or minority stockholder with
guaranteed representation on the district boards.
The district Federal Reserve Banks act as non-profit "bankers' banks" -- that is,
only commercial banking or depository institutions (and certain agencies of the
federal government) maintain deposits at the Federal Reserve, and only member
banking institutions and the US government are eligible to receive loans from it,
not private citizens nor other kinds of non-bank commercial enterprises. All banks
chartered as "national banks" by Federal law must be "member banks," that as
such are obligated to maintain most of their reserves as deposits in their accounts
at the Federal Reserve and to submit to detailed Federal Reserve banking
regulations. Many state-chartered banks and thrift institutions nowadays also
choose to be members of the Federal Reserve System and submit to its regulations
in order to enjoy the valuable services which the Fed provides to them.
The district Federal Reserve Banks operate clearing houses for checks and bank
drafts, issue new paper currency ("Federal Reserve notes") for sale to member
banks on demand, withdraw worn-out currency from circulation, sit in judgment
on the applications of banks that wish permission to merge with each other,
extend "discount loans" to member banks (with the member banks putting up their
own borrowers IOUs as collateral), and perform various miscellaneous regulatory
functions pertaining to the banks in their districts. When the Federal Reserve
System was originally created back in 1913, it was expected that the district
Federal Reserve Banks would each pursue slightly different monetary policies,
depending upon the economic conditions in their individual districts, so they were
given the authority to collect a wide variety of information and statistical data on
changes in regional business conditions to use in their decision-making. The high
degree of integration of the national economy has for many years made it
impractical for the district Federal Reserve Banks to maintain different levels of
interest rates or pursue differing policies regarding the growth or contraction of
the money stock (these policy decisions are made centrally for the entire country
by the Fed's Board of Governors in consultation with the district bank presidents),
but the 12 district banks are still a major source of detailed economic data used by
government policy-makers at both the national, state and local levels as well as by
private economic forecasters and business executives.
The primary reason why the banking industry generally supported the creation of
the Federal Reserve System and continues to support it today despite the
inconveniences imposed by the Fed's regulations, is the valuable privilege that
memberhip brings to the bankers to count on the Fed for large emergency loans of
cash if they someday need it to survive a "run" on their bank. In a bank "run,"
large numbers of depositors frightened by rumors that their bank is about to fail
suddenly begin crowding into the bank, demanding to withdraw all their deposits
in cash. This exhausts the very limited cash reserves normally kept on hand in the
bank's own vaults within a few hours. Since the large majority of the depositers'
dollars on deposit are always out on loan to the bank's credit customers, and since
it takes days or weeks to call in any sizable fraction of the loans outstanding, the
bank would have to "go bankrupt" and be liquidated by the courts unless it can
raise enough cash somewhere on short notice to pay off the panicky depositers
demanding their money. This is where the Fed steps in as rescuing angel with
armored cars full of cash pulling up to the beleagered bank within a few hours.
Bank runs are much more rare nowadays than they used to be, mainly because
most depositers today feel much less reason to panic when they believe that they
can get their money "for sure" -- either by virtue of the Fed's stepping in with
loans in the case of a short-term "liquidity crunch" if the bank in question is
relatively sound or (with more delay) by virtue of the insurance provided by the
Federal Deposit Insurance Corporation if the bank really does turn out to be
irretrievably in the red financially. And because runs are now both less likely to
happen and less dangerous to the bank even if they do, bankers can earn higher
profits by maintaining lower reserves than would otherwise be necessary and thus
being able to lend out a higher percentage of their deposits at interest.
Because many bankers with the "king's X" of Federal Reserve and FDIC backing
if they should get into difficulties might otherwise pursue excessively reckless
lending policies to increase their profits, the Federal Reserve's Board of
Governors was given the power to set minimum reserve requirements for the
member banks, to make regulations limiting the riskiness of banks' loan
portfolios, and to send "bank examiners" out periodically to audit the books of
member banks in order both to assure their compliance with regulations and to
safeguard depositors' accounts against fraud or embezzlement by bank managers
and employees.
The Fed's role as maker and executer of macroeconomically significant monetary
policies for the United States government centers around three major policy tools
at the Fed's disposal:
1. Manipulating the legally required reserve ratios ("reserve requirements")
for banks (and, less directly, for some other depository institutions, such as
savings and loans and credit unions)
2. Buying or selling U.S. government debt instruments (Treasury bonds,
notes and bills) on the private financial markets in New York ("open
market operations")
3. Setting the interest rate at which the Fed stands ready to make short-term
loans to member banks and other depository institutions that would
othertwise fall below the required reserve ratios (the Fed's "discount
rate").
Using its discretionary power to manipulate these policy tools, the Fed is able to
exercise substantial influence (but not complete control) over changes in the size
of the money stock and thus over interest rates, thereby influencing overall levels
of business activity and employment in the national economy (as well as
indirectly influencing the rates at which the dollar is exchanged for foreign
currencies and thus the flow of international trade and investment across U.S.
borders).
The Fed's Board of Governors sets policies regarding reserve requirements and
the discount rate all by itself, but changes in these two policy levers tend to be
relatively infrequent (perhaps once or twice a year on average for the discount
rate, and perhaps once every five to ten years on average for the reserve
requirement). The Fed's main policy tool of choice for exerting its influence on
the money stock and interest rates on a week-to-week basis is its "open market
operations." The necessary policy decisions about the Fed's on-going open market
operations (buying or selling varying quantities of U.S. bonds and other treasury
securities on the New York financial markets) are made for the Fed's Board of
Governors by a slightly expanded body called the Federal Open Market
Committee (FOMC). The FOMC consists of all seven members of the Board of
Governors plus five of the 12 banker-elected presidents of the Federal Reserve
district banks. (The president of the New York district bank is a permanent
member of the FOMC, while the other 11 district bank presidents serve one-year
terms on a rotating basis, with only four of them having the right to vote at any
given time.) The FOMC meets rather frequently in Washington, DC, but it has
also been the practice in recent years for the FOMC membership to convene
informally via long-distance telephone conference calls or one-on-one
communications with the Fed's Chairman on almost a daily basis.
Depression
A cyclical period of serious decline in the national economy, characterized by
temporarily decreased levels of business activity across most economic sectors,
and consequently by decline in Gross Domestic Product, relatively higher levels
of unemployment, rising numbers of business bankruptcies and (at least in the
most severe instances) a falling general price level (deflation). A general business
slump of somewhat less severity and shorter duration is typically referred to as a
recession. There is no precise dividing line that is generally recognized by
economists to distinguish a recession from a depression, and incumbent policymakers since World War II have almost always resisted describing their
contemporaneous economic situation as a depression, preferring the milder
sounding term "recession." The term "recession" has largely replaced the older
and more emotion-laden term "depression" in most economic literature as well,
except in referring to such catastrophic slumps of the past as "The Great
Depression" of the 1930s.
In the United States, there is a highly respected private academic research
foundation called the National Bureau of Economic Research that is the
uncontested leader in the collection and analysis of extremely detailed data
measuring multitudinous aspects of business activity. The NBER, after exhaustive
research, periodically decrees the definitive dating of the latest periods of decline
and recovery in the business cycle -- but unfortunately NBER's procedures are so
elaborate and so painstaking that recessions are nearly always clearly over by the
time that NBER officially verifies that they have begun. Consequently, the NBER
declarations are very useful for historians and economic theory-builders but
definitely not for time-pressured policy- makers and journalists. While everyone
is waiting for a definitive ruling by the NBER, there is a quick-and-dirty rule of
thumb for identifying the onset of recessions that is almost universally employed
by professional economists as a first approximation for policy purposes:
If inflation-adjusted Gross Domestic Product (or, alternatively, the closely related
measure called Gross National Product) declines for two successive quarters (i.e.,
six months in a row), a recession has begun, and when inflation-adjusted GDP
subsequently rises for two consecutive quarters, the recession has ended and
recovery is under way.
Corporation
Also referred to as limited liability corporation. A type of legal entity provided
for in the laws of most modern economically developed countries that two or
more investors may agree to create for the purpose of combining some of their
resources and going into business together. Corporations have the status of
"artificial legal persons" and thus may own property, make contracts, be held
responsible for committing crimes or torts, initiate court actions such as lawsuits,
and so on. In the United States, businesses organized as limited liability
corporations must indicate their status as such by including the word
"Incorporated" ("Inc.") in the name of the firm. In other countries, the same
purpose is served by using the equivalent abbreviations "Ltd." (Limited) or "S.A."
(Anonymous Society) at the end of the company's name. It is today by far the
most widespread and successful form of ownership of business property in all
advanced capitalist countries.
The key feature of the modern business corporation that sets it apart from simple
partnerships and sole proprietorships is that it provides the owners of the business
with the important legal protection of "limited liability," whereas these other
forms of business organization generally do not. If a failing business enterprise
that is owned as a sole proprietorship or partnership is unable to generate enough
money to pay its bills, the personal liability of the owners is unlimited -- that is,
the unpaid creditors of the business can take legal action to seize not only any
assets directly connected with the business itself but also the personal property of
any individual owner as well, up to the full amount of the debt. But if a limited
liability corporation goes belly up, the legal claims of the company's creditors
normally can extend only to the assets actually owned by the corporation in its
own name, and not to the individually-owned property of the company's
shareholders. The individual owner's shares in the corporation might become
worthless if the business fails, but he or she does not have to worry about the
Sheriff showing up to seize the house or the car or the family bank accounts to
pay off the rest of what the company's creditors are owed.
Protection from personal liability makes it much safer and therefore more
attractive for more individuals to use some of their savings to become part-owners
of very large business organizations. Without limited liability, even the tiniest
investment would put a shareholder's entire remaining fortune at risk. During the
Middle Ages and the early years of the Industrial Revolution, the corporate form
of ownership for business organizations was generally available only as a very
special privilege occasionally awarded by the government to a handfull of royal
favorites. But changes in the legal codes of Great Britain, the United States,
France and other economically progressive countries during the 19th century
removed most of the practical barriers to widespread adoption of the corporate
form of ownership. This made it much easier to raise capital for new business
enterprises. By allowing for pooling the savings of hundreds, thousands, or even
millions of individual investors at manageable levels of risk, the widespread
adoption of the corporate form of business ownership made extremely large scale
private investment projects practical for the first time in history, thereby
contributing greatly to the modern era's historic surge in economic growth that
continues up to the present day.
Derived demand
The demand for each of the factors of production is often referred to as a
"derived" demand to emphasize the fact that the relationship between the factor's
price and the quantity of the factor demanded by firms employing it in production
is directly dependent on consumer demand for the final product(s) the factor is
used to produce. If for some reason (say, for example, a spontaneous shift in
consumer tastes) the demand for men's hats increases (shifts to the right) so that
more hats than before can be sold at any given price, then the "derived" demand
for felt used in making hats will also increase (shift to the right) so that feltmakers will be able to sell more felt at any given price. (We would also expect the
hat-makers' demand for the labor of hatters and for specialized hat-making
machinery to shift to the right in a similar fashion in response to the public's
greater demand for hats.)
What is the mechanism by which a shift in demand for the final product is
translated into a shift in demand for the factors of production used in its
manufacture? The key is the change in the price of the final product brought
about by the shift in demand for it. If the demand curve for hats shifts to the right
and the (upwardly sloping) supply curve remains unchanged, then the equilibrium
price and quantity in the hat market will now involve both a somewhat higher
price for hats and a somewhat larger quantity of hats being produced and sold to
the public. (Because of the price rise, the marginal revenues earned by the
manufacturers per additional hat sold will be higher, so consequently their desire
to maximize profits will lead them to produce additional hats until the marginal
cost for the last hat rises to equal the new higher price.) But producing more hats
than before will require more of the relevant factors of production than before,
which they will want to purchase from their suppliers, shifting the demand curves
for each of the factors to the right. (This increase in demand for the factors in turn
will tend to raise the factor prices somewhat and to increase the quantity of them
sold, which then affects the factor producers' demand for their own necessary
inputs and brings about further price-and-quantity adjustments throughout the
economy in an ever-widening ripple effect.)
Division of labor
The division of a complex production process into a number of simpler tasks,
each one of which is undertaken by a different individual who typically (but not
necessarily) specializes in one task (or a very few tasks) on a more or less
permanent basis. The advantages of division of labor for enhancing human
productivity were first extensively analyzed by Adam Smith in his 1776 classic
The Wealth of Nations, where he coined the phrase. Whereas Smith's famous
analysis of the pin factory emphasized improvements in technical efficiency (the
time and physical movement saved by workers no longer having to switch from
one operation and set of tools to another), it also took note of the improvements in
allocational efficiency made possible by developing and then taking advantage of
workers' differing skills and talents according to the (at that time not yet named)
principle of comparative advantage.
In the broadest sense, the extension of the division of labor is the fundamental
feature of a modern or developed economy, in which gigantic increases in the
volume and variety of production have been attained -- but at the cost of
massively increasing economic interdependence within larger and larger
populations spread over larger and larger geographical areas. In such a complex
society, instead of each individual or family attempting to produce all or most of
what it consumes, the individual specializes in producing only a few kinds of
good or service (or perhaps only small components of a single good or service)
and then acquires all other desired goods or services from the production of other
specialists by means of mutual exchange (or, in non-market economies, perhaps
through coercive or customary transfer).
It is worth noting that, while economists tend to emphasize the immense
production- and efficiency-enhancing effects of a complex, geographically
extensive, and highly specialized division of labor and the markedly higher
average standard of living it makes possible, anthropologists, sociologists, and
social-psychologists (as well as many philosophers, artists and social theorists)
tend to focus more on other presumed non-economic side-effects of greater social
differentiation that they typically view in a much more negative light -- such as
the development of a diminished sense of wholeness or personal authorship that
may result in lessened emotional satisfaction from one's work; greater difficulties
in generating agreement on moral principles and a sense of social solidarity or
"belongingness" when the far-flung members of society live their lives in such
varied ways and develop such diverse interests; the insecurity of the individual's
social status when people are no longer assigned their place in society but must
continually compete with others to retain or improve their own social positions;
the loss of the sense of community mastery over one's fate that comes with
dependence upon distant and unknown people for the provision of most of one's
vital necessities, and so on. Analyzing and critiquing the many consequences of
an advanced and highly specialized division of labor is among the central themes
in the works of such pioneer modern social theorists as Jean-Jacques Rousseau,
Karl Marx, Ferdinand Toennies, Henry Maine, Max Weber, and Emile Durkheim,
to mention only a few, and these same topics still remain central to much of
contemporary social thought. [See: socialism].
Gross National Product (GNP)
An estimate of the total money value of all the final goods and services produced
in a given one-year period by the factors of production owned by a particular
country's residents. ("Final" goods and services means goods and services sold or
otherwise provided to their final consumers -- that is, to avoid double counting,
the value of steel sold to GM to make a car is not added separately into the GNP
or GDP totals because its value is already included when we add in the final sales
price of the car to the customer.)
GNP and GDP are very closely related concepts in theory, and in actual practice
the numbers tend to be pretty close to each other for most large industrialized
countries. The differences between the two measures arise from the facts that
there may be foreign-owned companies engaged in production within the
country's borders and there may be companies owned by the country's residents
that are engaged in production in some other country but provide income to
residents. So, for example, when Americans receive more income from their
overseas investments than foreigners receive from their investments in the United
States, American GNP will be somewhat larger than GDP in that year. If
Americans receive less income from their overseas investments than foreigners
receive from their US investments, on the other hand, American GNP will be
somewhat smaller than GDP.
Equivalent estimates of GNP (or GDP) produced in a given year may theoretically
be arrived at through at least three different accounting approaches, depending
upon whether the transactions that determine the prices of final goods and
services are looked at and tallied up by focussing on the buying or by focussing
on the proceeds from selling or by focussing on the nature of the products
themselves. Using the expenditure approach, you can estimate total GNP as the
sum of estimates of the amounts of money that are spent on final goods and
services by households (Consumption), by business firms (Investment), by
government (Government Purchases), and by the world outside the country (Net
Exports). Using the incomes approach, you can estimate total GNP by summing
up estimates of the different kinds of earnings people receive from producing
these same final goods and services:




Total wages and salaries
Profits of incorporated and unincorporated businesses
Rental incomes
Interest incomes
(Plus certain adjustments to account for wear and tear on productive assets like
plant and machinery -- depreciation -- and what are called indirect business
taxes). Using the product or output approach, you can estimate GNP by summing
up the output of all the various organizations producing goods and services in the
country, subtracting out the costs of their raw materials to avoid double counting
and making suitable adjustments for depreciation and for the value of imports and
exports. (In theory, all three approaches should give you the same grand totals -but of course in actual practice there will be discrepancies, and sometimes sizable
discrepancies, between the three estimates.)
Why does anyone bother to estimate the GNP or GDP? For the same reasons
statistical data is also gathered on unemployment rates, consumer price levels, the
international trade balance and so on -- to facilitate economic policy making by
government, to assist in planning by decision-makers in private business, and to
test economic theories. If government policy makers include among their goals
the promotion of economic growth and material prosperity in the national
economy as a whole by means of monetary and fiscal policy, they need to have
some reasonably precise way of telling how the economy is doing so as to decide
whether they should be pushing on the gas or stepping on the brakes.
Businessmen responsible for planning new investments in plant and equipment or
the introduction of new products can use macroeconomic data and economic
theory to forecast the likely levels of demand for their products and the probable
trends in their various costs of production. Finally, a historical record of such
statistics provides economists with the necessary data to test and refine their
theories about how the economy actually works (and, in the process, perhaps to
improve the policy makers' understanding of the likely consequences of their
policies).
GNP and GDP are among the most comprehensive measures of the overall
amount of economic production taking place in a national economy. Nevertheless,
the available statistics produced by government agencies are always far from
perfect estimates of what they purport to measure. They are measured in money
value terms to get around the problem of adding up total output of many different
goods and services that are normally expressed in many different kinds of
incomparable physical units. Microeconomic theory gives us lots of reasons for
believing that the relative prices at which products trade on a free market
represent reasonably unbiased estimates of the relative values consumers put upon
the various kinds of goods and services traded -- at least where there are no large
problems with externalities or public goods. But not all the final goods and
services produced in a society are traded on the free market, and the relative
contributions of these untraded goods and services to the consumers' material
living standards are therefore awfully difficult to estimate very well. Most of the
services produced by government, to take the largest example, cannot be valued at
a free market price because they are not offered for voluntary purchase on a free
market -- instead, the presumed beneficiaries of these services (the citizenry) are
forced to pay for them through taxes, whether they think the benefits are "worth
it" or not. In compiling the national accounts, the government statistical offices
simply make the heroic (and self-flattering) assumption that all the goods and
services provided by government are "worth" at least what was spent to produce
them, however outrageous the costs might have been and however worthless (or
harmful) the output might have been in the eyes of the citizenry.
A very large category of privately produced goods and services whose production
does not register at all in the official GNP or GDP statistics (because they do not
trade for money on the market) consists of householders' home production for
their own use -- things like backyard vegetable gardening, do-it-yourself home
and auto repairs, and the innumerable productive service activities of homemakers
in cooking, cleaning, sewing, childcare and so on. Another major omission from
the national accounts consists of goods and services that actually are traded for
money on markets -- black markets -- but the transactions are deliberately
concealed from government information collectors, either to avoid prosecution for
trading in illegal demerit goods (for example, drugs and prostitution) or simply to
avoid paying taxes or submitting to costly regulations on otherwise potentially
legal business transactions (working off the books, unauthorized import/export
trade, "moonshine" production of liquor, etc.). Economists' unofficial estimates of
the size of the American "underground economy" in recent years range from no
less than 5% to as much as 30% of official GDP!)
If one wants to use GNP (or GDP) to measure changes in overall levels of
economic production from one year to the next, then using money prices as a
"common denominator" for adding up all the disparate kinds of goods and
services introduces another problem for the accuracy of the estimates -- inflation.
Using money valuations to measure output at several points in time is a little like
using a rubber tape-measure to measure several different distances. Part of the
increase in GNP (or GDP) from one year to the next really is the result of
increased output, but part is also likely to be due merely to change in the value of
the currency unit used to measure it. Government statistical compilers try to deal
with this problem by producing estimates of "real" or "constant dollar" GNP (and
GDP), dividing their original ("current dollar") estimates by one or another of
many possible "price indexes" constructed to account for and remove the effects
of general price inflation -- but the problems of choosing and constructing
appropriate price indexes for this purpose are themselves numerous and admit of
no single unambiguous "best" answer to the problem.
It is also important to keep in mind that GNP and GDP (even when divided by the
size of the population to produce "per capita GNP") were never intended even
theoretically to be good measures of overall economic welfare: they are at best
only measures of recent levels or rates of productive activity. Overall societal
welfare is a broader concept than just economic welfare, and GNP (or GDP) is at
best only a very incomplete measure even of economic welfare, since levels of
current production do not necessarily reflect the levels of accumulated wealth
actually at the disposal of the citizenry. Moreover, the greater availability of
leisure time made possible by today's higher levels of productivity is pretty
clearly an improvement in our economic welfare over the days of the early 19th
century 14-hour workday. But this improvement does not show up at all in our
long-term GNP growth rates -- except possibly in a backwards way, since our
official GNP would no doubt be much higher than it is today if everyone still
worked a 14-hour workday using our modern technology instead of "wasting" all
those potential labor hours on "nonproductive" recreation, relaxation,
contemplation and socializing. And of course aggregate GNP and GDP do not
give any indication as to who gets to consume how much of the goods and
services produced, nor do their compilers exercise any "judgment" about what
these goods and services are or ought to be (as the advocates of the "equitable
distribution" and merit goods and demerit goods concepts would want to insist
upon as crucial determinants of societal welfare).
Gross Domestic Product (GDP)
An estimate of the total money value of all the final goods and services produced
in a given one-year period using the factors of production located within a
particular country's borders.
Economics
The branch of the social sciences concerned primarily with analyzing and
explaining human behavior in making decisions about the allocation of scarce
resources. Economists study the complex ways in which the following are
determined within a society:
1. What goods and services are to be produced (and in what amounts)?
2. By what means are these goods and services to be produced (using what
combinations of the various substitutable factors of production)?
3. How are the goods and services that are produced to be distributed among
the individual members and groups in the society's population?
Egalitarianism
A social philosophy or ideology placing primary stress on the value of human
equality and advocating radical social reforms so as to eliminate all forms of
economic, social and political inequality.
Factors of production
The scarce resources that are useful not so much for direct and immediate
satisfaction of human wants as for producing other goods or services. Economists
often find it useful for purposes of theoretical simplification to group the millions
of different sorts of factors of production into several very broad categories and
then discuss them as though all the items within each category were perfectly
substitutable for each other and therefore traded on a single market. The simplest
such conventional categorization of the factors of production divides them into
land, labor, capital, and sometimes also entrepreneurship and/or human capital.
Fiscal policy
That part of government policy which is concerned with raising revenue through
taxation and with deciding on the amounts and purposes of government spending.
Keynesian economic theorists believe that government can, and should, regulate
the overall pace of activity in the national economy through fiscal policy,
principally by deliberately having government borrow to spend more than it takes
in (running a budget deficit) to increase total demand for goods and services in
times of high unemployment and economic slowdown (the deficit being created
either by cutting taxes or by increasing spending or both). Similarly, Keynesian
theorists would advocate having government spend less than it takes in (running a
budget surplus) to cool down the national economy when too great an expansion
of total demand has pushed production to its physical limits and threatens to bring
on excessive inflation.
Free trade
A legal arrangement or national policy under which the exchange of goods and
services across international borders is neither restricted nor subsidized by
techniques of government intervention such as import tariffs, import quotas,
export subsidies, discriminatory regulations disadvantaging foreign buyers or
foreign sellers, trade embargoes, political manipulation of foreign currency
exchange rates, and the like. From their first origins in the writings of Adam
Smith up to the present, the classical and neoclassical schools of economic theory
have emphasized the advantages of free trade policies and the disadvantages of
protectionism for the improvement of popular living standards and the promotion
of overall rates of economic growth.
Although the theoretical arguments can and do become extremely detailed and
complex, the basic conclusion of classical and contemporary neoclassical
economic theory is that the advantages of free international trade represent
basically only a special case of the advantages of the free market system in
general. Although moving toward free trade may represent very real financial
losses for the small minority of companies with the political influence to get
themselves protected from foreign competition, these losses are normally much
more than counterbalanced by the gains to the great majority of the population.
Free trade leaves the country's consumers free to seek out the best bargains they
can find by not arbitrarily restricting their ability to choose foreign suppliers when
they offer a better deal than their domestic competitors in terms of price and/or
quality. This enhances competition and breaks down local monopolies. Free trade
also enhances the profitability of many other local industries by enabling them to
shop around for better deals in purchasing their supplies of raw materials and
other capital goods and thus helping them to reduce their costs of production. In
the most general terms, free trade makes possible a progressive extension of the
area within which specialization and the division of labor takes place according to
the principle of comparative advantage, producing gains from trade in overall
productivity and economic efficiency that result in higher average living standards
both at home and abroad.
Labor
The collective or generic name given to all the various productive services
provided by human beings, including physical effort, skills, intellectual abilities
and applied knowledge. Although a market society with a complex division of
labor involves hundreds or even many thousands of discrete types of labor
differentiated according to the kinds of skills and abilities required (each with
their own separate but interconnected labor markets), economists often find it
useful for theorizing to simplify the real situation by speaking as though there was
only one homogeneous kind of labor to be considered, with this single factor of
production being freely and easily substitutable across all different alternative
production processes for all different sorts of goods and services. When
economists moving beyond such very simple models of the economy want to
recognize the reality that acquiring specialized labor skills involves a process of
specialized learning that is often very costly and time-consuming, they are apt to
refer (somewhat contradictorily and confusingly) to "investment in human
capital" and treat the individual's process of decision-making in deciding what
sorts of training to pursue according to a marginal costs of production and
marginal revenues logic analogous to firms' decision-making processes in
choosing to invest in physical capital.
Human capital
A loose catch-all term for the practical knowledge, acquired skills and learned
abilities of an individual that make him or her potentially productive and thus
equip him or her to earn income in exchange for labor. The figurative use of the
term capital in connection with what would perhaps better be called the "quality
of labor" is somewhat confusing. In the strictest sense of the term, human capital
is not really capital at all. The term was coined so as to make a useful illustrative
analogy between investing resources to increase the stock of ordinary physical
capital (tools, machines, buildings, etc.) in order to increase the productivity of
labor and "investing" in the education or training of the labor force as an
alternative means of accomplishing the same general objective of higher
productivity. In both sorts of "investment," costs are incurred by investors in the
present in the expectation of deriving extra benefits over a long period of time in
the future. As in the case of ordinary investments in physical capital, investments
in human capital make economic sense to the extent that the value of the
additional future benefits to be expected (greater productivity and thus more
income for the worker and his employer) exceed the extra costs that have to be
incurred in the present to obtain them (costs of schooling or training programs,
production and income foregone while the individual is in training, the loss of
leisure and perhaps the experience of mental anguish undergone by the individual
in having to learn new things, etc.). Varying levels of past investment in human
capital provides one of the main explanation for the size of wage and salary
differentials among individuals: payment for an individual's labor in reality
includes not just payment for the employee's leisure time foregone but also a
premium that represents the going rate of return on his past investment in human
capital.
The analogy between human capital and real capital breaks down in one important
respect, however. Property rights over ordinary inanimate capital are normally
readily transferable by sale from one owner to another, and consequently markets
for capital goods can function easily and smoothly to reallocate such resources
from one project to another with minimal complications and transactions costs.
The value of resources that have been invested in physical capital by an investor
can often be readily recovered later (at least in good part) through resale, with the
proceeds being easily redeployed into purchases for consumption or reinvestment
in other types of capital goods as the investor may choose. However, human
capital is by definition inseparably embedded in the nervous system of a specific
individual and it thus cannot be separately owned apart from the individual's
living body itself. Except in societies that legalize slavery (or at least enforce very
long term transferable indentured labor contracts), human capital itself cannot be
directly bought and sold on the market -- only its temporary services as reflected
in the labor productivity of the one individual who alone can own it. If an
employee chooses to quit his or her job (perhaps because of an offer of much
higher pay by a competing firm in the same industry), then any past investment
the employer may have made to upgrade the employee's job skills is lost to the
firm from the minute the former employee walks out the door for the last time.
The only person who can invest in human capital with full confidence that he will
not be arbitrarily deprived of its fruits in the future without compensation is the
individual in whom the investment is made, so other firms or individuals therefore
have much less incentive to invest resources in him or her in this way, even if this
might be the cheapest way to increase productivity. Even the individual in whom
the human capital is to be embedded may be somewhat deterred from investing by
the fact that such an investment is necessarily very illiquid -- that he cannot later
recoup any part of the value of his own investment in human capital by selling it
off if he should desire to go into some other line of endeavor where the skills
involved are not useful.
Impoundment
A traditional budgeting procedure by which the President of the United States
once could prevent any agency of the Executive Branch from spending part or all
of the money previously appropriated by Congress for their use. He would
accomplish this, in essence, by an executive order that would forbid the Treasury
to transfer the money in question to the agency's account. (The Constitution
provides that no money from the Treasury can be spent without a specific
Congressional appropriation, but it is silent on the question of whether all money
appropriated by Congress actually has to be spent.) All American presidents since
John Adams asserted the right to impound appropriated funds, and presidents
often used this as a way of making relatively small cuts in Federal spending on
programs that they deemed unwise or unnecessary, despite occasional
murmurings of dissatisfaction from Congressmen annoyed by the cancellation or
trimming of some of their pet pork-barrel projects. In 1973-1974, however,
President Nixon made unusually large-scale use of impoundment in his efforts to
fight the unusually serious inflationary pressures of the time by trimming back the
budget deficit. President Nixon impounded nearly $12 billion of Congressional
appropriations, which represented something over 4% of the spending Congress
had appropriated for the coming fiscal year. Congressional leaders, who were
already up in arms against the Nixon White House because of the Watergate
scandal, rebelled against the implicit presidential rebuke of their judgment and
authority over spending decisions posed by such large-scale impoundment. In
1974, Congress passed legislation purporting to make the old practice of
presidential impoundment illegal and legally requiring the Executive Branch to
spend every last penny that would ever be appropriated for it by Congress in the
future. The administration denied that Congress had the constitutional authority to
over-ride the President's control over the executive branch agencies in this
manner, but a Federal Court eventually upheld the Congress's position on this
matter, and the new Ford Administration chose to acquiesce in this lower court
ruling rather than to further antagonize the already hostile Congress with an
appeal to the Supreme Court.
Inflation
In contemporary usage, a sustained rise over time in the general level of prices,
normally measured by a weighted index of prices of a large and representative
sample of goods and services (both consumers' goods and producers' goods)
regularly traded in the economy under consideration. (In 19th century usage, the
term referred more specifically to any sustained expansion in the stock of money
available within the economy under consideration -- the eventual consequence of
which would normally be a generalized increase in prices.)
When the quantity of money available in the economy begins to exceed the
amount that firms and households (in the aggregate) feel they wish to keep on
hand to finance their expected volume of trading in the foreseeable future, people
tend to increase their rate of spending all at once, shifting the demand curves for
nearly all goods and services to the right at the same time and thus driving up the
general price level -- which is just another way of saying that each unit of money
begins to be worth less than before in its purchasing power. Such an acceleration
of spending may happen for any of a number of reasons:
1. The money stock itself is rapidly expanding
2. The available stocks of many goods have suddenly shrunk dramatically
due to natural disaster, wartime destruction, or political interruption of
established international trading relationships through embargoes or
blockades
3. The average amounts of money people want to keep on hand is shrinking
due to rising guesstimates of what future inflation rates might be
4. Increasing availability of new close money-substitutes like credit cards, or
5. because households' willingness or ability to save is for some reason
sharply decreasing.
History strongly suggests, however, that sustained inflation at rates of more than
four or five percent per year in "normal" times is nearly always due primarily to
government or central bank policies of rapid monetary expansion rather than to
anything else that may be going on in the private sector to influence the public's
demand for cash balances.
If the money stock continues to increase a great deal faster than the public's total
demand for cash holdings, the inflationary process begins to feed upon itself.
Initial experience with accelerating inflation quickly convinces the public that the
future purchasing power of their money holdings is going to be very much less
than it is in the present -- leading people to reduce still further their desired
amounts of money to hold and further accelerating the general rise in prices
because of their desperate efforts to spend away their money as quickly as
possible, before its value melts away. When such an inflationary panic once takes
hold, the result is apt to be hyperinflation, in which prices may begin increasing
by several hundred percent (or even several thousand percent) per month until the
monetary system collapses altogether and people resort to primitive barter (or the
use of more stable foreign currencies, if available) rather than accept the
government's worthless money as payment for their goods or services.
Interest rate(s)
The price(s) of obtaining the temporary use of money that one borrows from
someone else who actually owns it, normally expressed as a percentage of the
amount borrowed per year. Since loans and loan repayment extend over
considerable periods of time and entail more complex security arrangements than
a simple cash-on-the-barrelhead exchange, interest rates to be paid are normally
spelled out as part of a relatively complex written contract between borrower and
lender. Like most other prices in an advanced market economy, the going levels
of interest rates are determined in rather well-developed, highly competitive
markets (in this case, they are referred to as "credit markets" or "financial
markets") by the interaction and mutual adjustment of supply and demand. The
demand for loanable funds mainly comes from firms who need them for
investment purposes, from households who want them mainly for the purchase of
big-ticket consumer durable goods like houses or autos, and from national, state
and local governments who want them in order to make up the difference between
the amount of money available in the treasury from tax collections and the
(larger) amount of money the government has nevertheless decided to spend in
financing its various projects and programs. The supply of loanable funds comes
mainly from individual household and business firm savings placed with financial
intermediary firms such as banks, thrift institutions, and insurance companies or
else mobilized directly from individual lenders through the issuance of bonds,
notes and other credit instruments tradeable on financial markets. In economies
such as our own that allow fractional reserve banking, a considerable portion of
the supply of loanable funds comes through credit creation by the central bank
and the banking system. It is a serious oversimplification to refer to "the" rate of
interest because at any given time there will normally be a whole range of
different rates of interest that vary according to (among other things) the
particular form of lending (bank savings deposits, personal i.o.u.'s, secured
mortgages, collateralized bank loans, corporate bonds, U.S. Treasury notes, etc.),
the contractual terms upon which the money is loaned (duration of the loan,
repayment schedule, fixed rate or floating rate, national currency in which the
loan is to be repaid, etc.), and the perceived degree of risk that the particular
category of borrower will default on his repayments. For theoretical or analytical
purposes, economists often like to postulate the existence of a "pure" (completely
risk free) rate of interest (closely approximated by the rate of return on very shortterm U.S. government Treasury bills) and then analyze other real world interest
rates in terms of various factors peculiar to particular types of loans that each
cause some sort of "premium" to be added on to the pure rate of interest in
proportion to the various kinds and degrees of risk entailed (risk of default, risk of
inflation or currency devaluation reducing the real value of the repayment over
time, risk that the debt would be hard to resell if the lender unexpectedly needs to
get his money out before the term of the loan expires, etc.)
The level of interest rates plays an extremely important role on either the supply
side or the demand side of very many other important markets in the economy,
and for that reason interest rates are often perceived by government policy makers
as a potentially powerful tool for manipulating the economy in the interests of
promoting growth, controlling inflation, stimulating exports and so on. Largescale investment projects by business firms such as building new factories (or
starting up new businesses) are often financed largely by borrowing, and the level
of interest rates plays an important role in determining whether a particular
investment project under consideration seems likely to be profitable or not. Thus,
a period of very high interest rates (especially very high long-term interest rates)
is likely to reduce greatly the amount of new investment undertaken -- with
obvious short-term consequences for the level of employment in the construction
and machine-tools industries and with longer-term consequences for the country's
overall economic growth in the future. Similarly, the level of interest rates plays a
large role in the willingness and ability of consumers to purchase new houses,
recreational vehicles, automobiles, refrigerators and other big ticket items -- with
important implications for the profitability and level of employment in these
industries. Interest rates available on savings accounts, bonds, and the like play a
role in determining household decisions about how much income to save and how
much to spend on immediate consumption. Interest rates (and especially their
relationship to the levels of interest rates in other countries) also play a crucial
role in affecting the volume of savings entering the country from abroad for local
investment or leaving the country for foreign investment purposes -- thus
influencing not only investment activity but also the exchange rates of the
domestic currency in relation to foreign currencies, and thus the attractiveness of
the country's exports to potential purchasers abroad. For all these reasons (and
others), governments in the 20th century are nearly always deeply involved in
deliberate efforts to influence interest rates by means of monetary policies that
encourage the expansion (or, occasionally, contraction) of the money stock
through regulatory pressures on the banking system.
Investment
All income expended by firms or government agencies on capital goods for use in
their productive activities. Thus aggregate investment in a national economy is the
total amount of spending in order to maintain or increase the stock of physical
goods not intended for immediate consumption by the purchasing entity but rather
for use in producing other kinds of goods or services to be delivered to others.
(Note that the economist's sense of the term is somewhat narrower than the
general population's use of the term, in that the economist would exclude the
purchase of purely financial paper assets like bonds or shares of stock from
coverage by the term "investment.") All forms of investment thus require prior
saving from income, but not all savings are for the purpose of investment.
Macroeconomics
The subdivision of the discipline of economics that studies and strives to explain
the functioning of the economy as a whole -- the total output of the economy, the
overall level of employment or unemployment, movements in the average level of
prices (inflation or deflation), total savings and investment, total consumption and
so on. The focus of much of macroeconomic theory is analysis of the ways in
which conscious government policies (and the unintended secondary
consequences of these policies) can influence the overall "economic health" of the
country for good and for ill.
Market economy
An economy in which scarce resources are all (or nearly all) allocated by the
interplay of supply and demand in free markets, largely unhampered by
government rationing, price-fixing or other coercive interference. In classifying
real historical economies, the level of "marketization" is not primarily an either/or
issue but rather a matter of degree. The greater the proportion of the goods and
services produced in the society that are allocated by market processes (rather
than by government edict or the operation of unchangeable custom), the more
meaningful it is to refer to its economy as a market economy -- and the more
useful is the abstract economic theory of the operation of markets likely to be for
understanding and even predicting economic behavior within that society.
Probably the most critical single distinction between "basically market" and
"basically non-market" (socialist, feudal, hunter-gatherer, etc.) economies is
whether or not the determinations of what is to be produced and of the
corresponding allocation of producers' goods (land, raw materials, machinery, and
other "capital," as well as the services of labor) are accomplished primarily
through free markets rather than primarily through government command or
unalterable custom.
The concept of a market presupposes the existence of certain sorts of property
relations in the society involved. At least some goods and services must be legally
or socially regarded as alienable property -- that is, there must be ascertainable
individuals (or group representatives) who are recognized as having not just the
right to use particular scarce economic resources for their own purposes but also
the discretionary authority permanently to transfer such rights of use to someone
else in exchange for some mutually agreeable quid pro quo, such as money or
other goods or services. Not all human societies have recognized any such rights
to transfer ownership, and most historical human societies have forbidden or
placed stringent limits on the transferability of at least certain kinds of recognized
property rights. In many societies (including most of Europe during the Middle
Ages), individual or family rights to the perpetual use of particular plots of land
were well established and protected by law -- but such rights only rarely could
legally be sold to someone else because the land was socially regarded as
fundamentally the inalienable property of either the local community as a whole
or of the tribe or clan or church or perhaps of the reigning royal family. And even
in the USA since 1865, while each person's ownership of his or her own body is
well established, the law will still not allow you to make a binding contract to sell
yourself into slavery or even to auction off your spare bodily organs for purposes
of a surgical transplant.)
It is worth noting for clarity's sake that the concept of a market does not logically
presuppose the existence of "private property in the means of production" in the
sense that private individuals or family households are the owners of land and
capital and thus the recipients of profits, interest, rent etc. One may at least
theoretically conceive of an economy of market socialism, in which workers'
collectives, consumers' cooperatives, village communes or even autonomous state
agencies leased from the state or held actual title to land, mines, factories,
machinery and so forth -- so long as the socialist production organizations were
free to buy and sell their output and and the use of their assigned land or capital
assets to each other at freely negotiated prices responsive to conditions of supply
and demand (assuming, of course, they are allowed to keep effective control of
the bulk of the proceeds). There are, of course, both theoretical and practical
problems with market socialism, and the costs and benefits of capitalist markets
cannot be uncritically attributed to such a system. The larger point is that socialist
economies have historically included varying proportions of "remnant" market
elements in their make-up, and the theoretical possibilities for additional "hybrid"
forms are numerous.
Microeconomics
The subdivision of the discipline of economics that studies the behavior of
individual households and firms interacting through markets, how prices and
levels of output of individual products are determined in these markets, the
interconnections by which different markets affect each other, and how the price
mechanism allocates resources and distributes income.
Money stock
(Also sometimes loosely referred to as the money supply, a term that, strictly
speaking, should be reserved for the entire supply schedule of associated interest
rates and the quantities of money that would be created at those rates.) The money
stock is the total amount of money available in a particular economy at a
particular point in time. Since many different things may serve more or less well
as money (or close money substitutes), and since several different sorts of things
may be serving as money at the same time in any particular economy, precise
definition and measurement of the money stock presents some serious practical
problems for the policy maker who wishes to use manipulation of the growth (or
contraction) of the money stock as a tool of economic policy.
The narrowest definition of the money stock in common use by the advanced
industrial countries today ("M1") includes only the paper currency and coinage in
circulation among the public plus the total balances instantly available to
depositors in privately held checking accounts ("demand deposits" or "sight
deposits") in the country's commercial banks and similar depository institutions
(like savings and loans, credit unions, etc.). (A very large proportion of checking
account money, of course, is simply created by the banks themselves as they
extend loans to borrowers by simply crediting their borrowers' checking account
balances with the amounts loaned). Travelers' checks are also included in M1 in
some countries, including the US.
"M2," the next broadest measure of the money stock, adds on to the totals
included in M1 the total amount of deposits in short-term savings accounts and
small certificates of deposit. There are a number of still broader definitions of the
money stock ("M3," "M4," "L," etc.) that go on to add in such only slightly less
liquid money-like assets as checkable money market mutual funds, larger
denomination bank certificates of deposit, credit card credit limits, pre-approved
lines of credit, and so on.
Supply side economics
A school of thought within the economics profession emphasizing that the main
source of a country's economic growth is constant improvement in the efficiency
with which resources are allocated for production. While the policy
recommendations of the rival Keynesian school tend to focus almost entirely on
what government can do to stimulate or restrain aggregate demand in the shortrun so as to even out the business cycle, supply-side policy analysts focus on
barriers to higher productivity -- identifying ways in which the government can
promote faster economic growth over the long haul by removing impediments to
the supply of, and efficient use of, the factors of production. Supply-siders believe
that unwise provisions of the tax laws (and especially high marginal rates of
personal and corporate income taxation) produce very damaging incentives that
lead people to work less and to invest less (and to do both less efficiently) than
they otherwise would. Supply-side policy recommendations typically include
deregulation of heavily regulated industries, promotion of greater competition
through lowering protectionist barriers to international trade, and measures to
repeal special subsidies and tax loopholes targeting particular industries in favor
of lower and more uniform tax rates across the board. Supply-side economics
became particularly well-known to the general public during the 1980s because of
its advocacy by one influential faction of economic policy-makers in the Reagan
administration, leading to the use of the term "Reaganomics" to denote many of
the ideas of the supply-siders. Supply-siders played a much smaller role in
economic policy-making under the Bush administration, as the focus of attention
shifted toward controlling the size of the budget deficit and away from the earlier
"Reaganomics" preoccupation with accelerating the country's rate of economic
growth.
Regressive tax
A tax that tends to take a larger percentage of the incomes of lower income
citizens than it takes from the incomes of higher income citizens. Examples: a poll
tax, a flat percentage tax on only the first so many dollars of income (like the
social security tax) or a sales tax on consumption items of common necessity (like
groceries).
Progressive tax
A tax that tends to take a smaller percentage of the incomes of lower income
citizens compared to the percentage it takes of the incomes of wealthier citizens.
Example: an income tax with steeper rates for those in higher income brackets, or
a special sales tax levied only on expensive “luxuries” like yachts or jewelry.
Tax, taxation
A compulsory transfer of money (or occasionally of goods or services) from
private individuals, institutions or groups to the state. The amount and timing of
the levy exacted from the individual taxpayer may be determined on the basis of
any of a very large number of factors, but historically the most common sorts of
tax have been levied based on the wealth or the income or some other
characteristic of the particular taxpayer at a given time ("direct taxes" like income
tax, social security tax, real property tax, estate tax, poll tax, business or
professional license fees) or as some form of compulsory surcharge on one or
more types of private trade or other voluntary transactions ("indirect taxes" like
general sales taxes, specialized excise taxes, import tariffs, marriage licenses, and
so on). In addition to the obvious function of raising revenue to finance
government purchases of goods and services or income transfer programs,
taxation may also be used deliberately as a policy instrument by which
government seeks to influence the behavior of various segments of the citizenry
by raising the costs of choosing to engage in the kinds of behavior on which taxes
are imposed -- the classic examples being "sin" taxes to discourage consumption
of tobacco and alcohol or protective import tariffs imposed to discourage the
purchase of foreign-made products. (Of course, all forms of taxation will have an
impact on the incentives facing the citizenry and thus will affect their behavior -but frequently these non-revenue effects will not have been analyzed in advance
and therefore do not represent deliberate policy. Legislators are rather regularly
astonished by the unexpected -- and often negative -- secondary effects of their
enactments, such as cigarette tax increases in New York producing diminished
revenues due to increases in smuggling of cheap untaxed cigarettes, or newly
imposed luxury taxes on yachts meant to soak the rich creating mass blue-collar
unemployment in the boat-building industry due to greatly diminished sales.)
Right-to-work laws
State laws that make it illegal for labor unions and employers to enter into
contracts that provide for a business to employ only union members in the jobs
covered by the contract. One typical version of a right-to-work law reads “No
person may be denied employment, and employers may not be denied the right to
employ any person, because of that person's membership or non-membership in
any labor organization.” Labor union leaders typically seek the repeal of right-to-
work laws because much lower percentages of workers choose to join unions and
pay dues in states where such laws are in effect. Defenders of right-to-work laws
tend to argue that workers who refuse to join unions mainly do so because they
just do not value the collective bargaining services that unions perform and/or
because they disagree with the political causes that unions support with their dues
money. Opponents of right-to-work laws tend to see refusal to join a union mainly
as attempting to be a free rider who enjoys the very real benefits of union
representation without having to pay his fair share of the cost. About 20 US states
have some version of such a law presently in effect.
Price controls
A form of government intervention in the economy in which a government
agency uses its law-making power to regulate the prices at which otherwise
voluntary private exchanges may take place. The government agency may attempt
to fix and enforce the exact prices at which a particular good or service may be
sold (as for example when state regulatory commissions fix the rates for
electricity, gas or water to be sold by monopoly utility companies in particular
geographic areas). Alternatively, the government agency may be content to set
“ceiling prices” or “floor prices” for particular goods or services. Ceiling price
controls set a maximum price that may be charged but do not prohibit transactions
at lower prices below the ceiling price (for example, rent control). Floor price
controls set a minimum price that may legally be charged but do not prohibit
transactions at higher prices above the floor price (for example, minimum wage
laws).
Savings
All income of households (and firms) that is neither immediately spent on goods
and services for final consumption nor taken by the government as taxes. Such
savings may be held as balances in bank accounts or as cash on hand. Savings
may be held for the purpose of subsequent investment or for some other purpose,
such as accumulating sufficient funds for future consumption spending on big
ticket items, maintaining an emergency reserve against the possibility of
unpredicted consumption expenses, providing for post-retirement consumption
spending, or even for the perverse psychological pleasures of hoarding in the
miserly tradition of Silas Marner.
Laissez-faire
Literally, French for "Let do." The classical liberal (and modern libertarian)
doctrine that the economic affairs of society are best guided by the free and
autonomous decisions of individuals in the marketplace, to the near exclusion of
government interference in economic matters. That is, the doctrine that
government should almost always leave people alone and let them do as they
please, so long as they respect the personal and property rights of others.
Subsidy
In general, a special money payment by a government to one or more firms in a
favored industry, usually for the purpose of enabling them to sell one or more of
their products at a price below their costs of production (or at least at a price
below the free market price). Subsidies are typically advocated either to promote
more widespread consumption of some good or service deemed to be especially
essential or meritorious by the government ("merit goods"), to boost the levels of
production of goods whose manufacture or consumption involves sizable
"positive externalities" or partake of the nature of "public goods," or sometimes
simply to stave off bankruptcy and unemployment in a declining industry or
segment of an industry whose owners and/or workers enjoy a lot of political
influence.
Scarcity
A condition where there is less of something available than at least some people
would like to have if they could have them at no cost to themselves. Note that this
technical economic definition of “scarcity” differs greatly from the notion of
scarcity as “unusual rarity” that predominates in most ordinary language. (For
example, automobiles are not currently “scarce” in Los Angeles in the sense of
being rare or unusual to see, but they are definitely “scarce” in the economic
sense because many Angelenos would certainly take more of them if they were
being given away for free.) Because the total quantity of goods and services that
people would like to have always far exceeds the amount which available
economic resources are capable of producing in all known human societies,
people as individuals and/or as members of larger social units must constantly be
making choices about which desires to satisfy first and which to leave less than
fully satisfied for the time being. That is, they must constantly decide how best to
allocate (apportion or distribute) the scarce resources available to them among the
various alternative uses to which they can be put. Thus scarcity is the fundamental
condition that gives rise to the patterns of choosing behavior whose study
constitutes the main focus of the academic discipline of economics.
Public sector
The part of an economy in which goods and services are produced and/or
(re)distributed by government agencies.
Private sector
The part of an economy in which goods and services are produced and distributed
by individuals and organizations that are not part of the government or state
bureaucracy.
Supply, law of
Other things being held constant, the higher the price of a good (or service), the
larger the quantity of that good (or service) that will be offered for sale in a
particular time period.
Tariff
A tax imposed on goods imported from outside the country that is not imposed on
similar goods from within the country. Import tariffs may be levied on an ad
valorem basis, i.e., as a certain percentage of the estimated market value of the
imported item; or on a "specific" basis, i.e., as a fixed dollar amount per unit
imported. Import tariffs (or "duties") may be imposed mainly for the purpose of
raising revenues because they are relatively cheap and easy taxes for a small or
poorly organized government to collect, but more usually in developed industrial
societies they represent a tiny fraction of revenues and are imposed primarily for
other reasons of economic policy. "Protective" tariffs allow domestic producers of
the good in question an artificial competitive advantage over their foreign
competitors (largely at the expense of domestic consumers of these products) by
making it impossible for the foreign producer to sell his goods as cheaply as he
otherwise would -- thus allowing favored domestic producers to enjoy higher
prices, a bigger market share, and bigger profits.
Unemployment
A situation which exists when members of the labor force wish to work at the
prevailing wage or salary rates for their skills, but cannot get a job. The concept
thus refers to "involuntary" unemployment only, rather than the voluntary
decision of someone to choose leisure (or productive activity outside the cash
economy such as housewifery) rather than gainful employment at prevailing rates
of pay. Most post-World War II governments have made it a major goal of their
economic policies to keep total unemployment in their national economies at
relatively low levels (subject to certain practical constraints and trade-offs
imposed by their pursuit of other important goals such as economic growth, low
inflation, competitiveness in international trade, and so on).
Unemployment rate
A measure of the extent of unemployment in the labor force at some particular
time, expressed as a percentage of the total available labor force. Nearly all
national governments now have some statistical agency or department charged
with gathering the necessary data and estimating the unemployment rate at
frequent intervals (monthly or quarterly) for the guidance of policy-makers. In
broad terms the underlying concepts are pretty similar from one country to the
next: the number of people classified as unemployed is to be divided by the
number of people classified as being in the available labor force, with the result
expressed in percentage terms. However, differences from country to country in
classification rules and practical data collection methods used for estimating both
the numerator and the denominator of this fraction make precise international
comparison of unemployment rates very difficult, if not impossible. The use of
jobless totals derived from the agencies that distribute unemployment insurance
benefits is particularly suspect but nevertheless widely practiced by some
countries' official statistical agencies. For example, some people may falsely
claim they would accept a job offer at current wage rates when in fact they are
making no effort (or only a token show of effort) to locate such a job,
misreporting their intentions so that they may continue to draw unemployment
benefits for a time. Other people may be actively, even desperately, seeking a job
and yet not show up in such a count because they are technically ineligible for
unemployment benefits (perhaps through lack of previous work experience or
through having exhausted the time-limit) and so do not bother to report the
success or failure of their job-hunting efforts to the government unemployment
office. (Well-designed sample surveys of the population or of employers have
much better validity for measuring the true unemployment rate but still have
credibility problems of their own. For example, hundreds of thousands or even
millions of people who are really gainfully employed but whose work is in illegal
activities -- such as bootlegging, prostitution, drug-dealing, loan-sharking, illegal
gambling operations, smuggling, or simply working conventional trades "off the
books" to avoid taxes -- cheerfully deny having a job when questioned by
government pollsters in suits who might well inform on them to the police.)
Entitlement program
The kind of government program that provides individuals with personal financial
benefits (or sometimes special government-provided goods or services) to which
an indefinite (but usually rather large) number of potential beneficiaries have a
legal right (enforceable in court, if necessary) whenever they meet eligibility
conditions that are specified by the standing law that authorizes the program. The
beneficiaries of entitlement programs are normally individual citizens or
residents, but sometimes organizations such as business corporations, local
governments, or even political parties may have similar special "entitlements"
under certain programs. The most important examples of entitlement programs at
the federal level in the United States would include Social Security, Medicare,
and Medicaid, most Veterans' Administration programs, federal employee and
military retirement plans, unemployment compensation, food stamps, and
agricultural price support programs.
The existence of entitlement programs is mainly significant from a political
economy standpoint because of the very difficult problems they create for
Congress's efforts to control the exact size of the budget deficit or surplus through
the annual appropriations process. It is often very hard to predict in advance just
how many individuals will meet the various entitlement criteria during any given
year, so it is therefore difficult to predict what the total costs to the government
will be at the time the appropriation bills for the coming fiscal year are being
drafted. This makes it even harder for government to smooth out the business
cycle or pursue other macroeconomic objectives through an active fiscal policy -because these objectives require careful pre-planning of the size of the budget
deficit or surplus to be run. In the first place, the amount of money that will be
required in the coming year to fund an entitlement program is often extremely
difficult to predict in advance because the number of people with an entitlement
may depend upon the overall condition of the economy at the time. For example,
the total amount of unemployment benefits to be paid out will depend upon the
changing level of unemployment in the economy as the year wears on. Some very
large entitlement programs (including Social Security pensions and government
employee retirement programs) have been "indexed" to inflation, so that the size
of the benefit is periodically adjusted according to a fixed formula based on
unpredictable changes in the Consumers' Price Index. Perhaps more significantly,
the amount of spending on entitlement programs is impossible for the Senate and
House Appropriations committees to even attempt to adjust or to control because
those committees do not have the jurisdiction to rewrite the laws that specify who
gets how much and under what conditions. The various specialized standing
committees who do have the jurisdiction to rewrite authorizing legislation each
tend to be dominated by members whose political interests lie in expanding their
particular entitlement program, not in cutting it back, and the political influence of
the organized special interest groups that support the programs tends to be
overwhelming on the specialized committees when such proposals arise.
Since the middle 1980s, entitlement programs have accounted for more than half
of all federal spending. Taken together with such other almost uncontrollable (in
the short run, that is) expenses as interest payments on the national debt and the
payment obligations arising from long-term contracts already entered into by the
government in past years, entitlement programs leave Congress with no more than
about 25% of the annual budget to be scrutinized for possible cutbacks through
the regular appropriations process. This very substantially reduces the practicality
of trying to counteract the ups and downs of the overall economy through a
"discretionary" fiscal policy because so very little of the budget is available for
meaningful alteration by the Appropriations and Budget committees on short
notice.
Key taxpayer provisions:
Tax credit for workers: for 2009 and 2010 there is a "making work pay" tax credit of up to $400 for
working individuals and up to $800 for couples
Temporary suspension of taxation on unemployment benefits: the jobless get a little more help with
a $25 increase in weekly benefit checks through 2009 and suspension of federal tax on the first $2,400 of
unemployment benefits received in 2009
Retirees and disabled individuals: those receiving Social Security benefits and individuals on
disability will receive a one-time payment of $250 in 2009
First-time home buyer credit: increased to $8,000 for qualified first-time homebuyers purchasing
homes after Dec. 31, 2008 and before Dec. 1, 2009; repayment requirement waived unless sold or no longer
principal residence within 36 months
"American Opportunity Tax Credit" for education: an 'enhanced' Hope credit applies to the first four
years of college; it provides 100% credit for the first $2,000 and 25% for the next $2,000 on qualified
expenses such as tuition and books; the credit is 40% refundable, meaning even taxpayers who have no tax
liability can receive a credit for 40% of qualified college expenses, up to $1,000
529 plans: qualified computer technology and equipment is now allowed as higher education
expenses from the plan, so distributions from 529 plans to buy a computer, for example, for college will not
be taxable
Earned Income Tax Credit: increased EITC amounts for families with 3 or more children and
additional marriage penalty relief
Additional Child Tax Credit: earnings threshold is lowered to $3,000, helping more people qualify
for the credit and receive more money; for 2008 the earnings threshold was $8,500
Vehicle purchase: state and local sales taxes paid for purchases of qualified new motor vehicles
are deductible
AMT: the one year typical patch for 2009 of the Alternative Minimum Tax (AMT) to prevent as many
as 24 million middle-income households from being hit with a tax that was originally designed to prevent the
very wealthy from avoiding taxes
Where is Your Money Going?
FR E Q U E NT L Y A SKE D Q U E ST I O N S
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What is Recovery.gov?
Where can I learn more about how the American Recovery and Reinvestment Act will affect
the budget?
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How will the Recovery Act work?
I heard I'd be able to track recovery funds. Why can’t I do that?
Who runs Recovery.gov?
I want to help. What can I do?
How can I see how much recovery money is coming to my community?
What is the purpose of the new legislation?
Where can I find the full text of The American Recovery and Reinvestment Act of 2009?
What type of programs will this recovery package fund?
What will I be able to locate on Recovery.gov?
What is a better way to find the information I’m looking for - browsing or searching?
How does Recovery.gov differ from USASpending.gov?
How can I contact the Administration with questions or comments about Recovery.gov
and the recovery package?
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Is Recovery.gov accessible for people for with disabilities?
What is a fiscal year (FY)?
Is the spending data on recovery.gov available in a format (like XML) that developers can
use to create mashups and gadgets?
Q: What is Recovery.gov
A: Recovery.gov is a website that lets you, the taxpayer, figure out where the money from the
American Recovery and Reinvestment Act is going. There are going to be a few different ways to
search for information. Within days after the signing of the legislation, Federal agencies will start
distributing funds, and you will be able to see which states, Congressional districts, and even
Federal contractors are receiving them. As soon as we are able to, we'll display that information
visually, through maps, charts, and graphics.
Q: Where can I learn more about how the American Recovery and Reinvestment Act will affect the budget?
A: The Congressional Budget Office (CBO) has calculated the impact that the American Recovery
and Reinvestment Act will have on the federal government's budget deficit. You can review those
calculations in full, or read a summary on the CBO blog. For more information visit the White
House website or, for legislative information, the Library of Congress's THOMAS.
Q: How will the Recovery Act work?
A: Very soon, the different agencies -- such as the Departments of Education; Health and Human
Services; and Energy -- will decide who will receive award grants and contracts. Sometimes the
money will go to a state government; other times, the funds will go directly to a school, hospital,
contractor, or other organization. Agencies will then deliver that information to the Recovery.gov
team. We will subsequently make the information available on Recovery.gov, and you will be able
to track where the money is going. You'll be able to search by state or even by Congressional
district; you'll be able to look up names of Federal contractors or other recipients of Federal
dollars; and you'll be able to send in comments, thoughts, ideas, questions, and any responses
you have to what you find.
Q: I heard I'd be able to track recovery funds. Why can't I do that?
A: You aren't able to track funds yet because we have not yet started receiving information from
Federal agencies on how they are going to allocate the money. It takes a little bit of time for them
to make sure your money is going to be spent wisely. Right now, the site features an overview of
the law and an explanation of what it is intended to accomplish. You will have access to data as
soon as we begin receiving it from agencies.
Q: Who runs Recovery.gov?
A: The American Recovery and Reinvestment Act establishes an oversight board of inspectors
general (the watchdogs of government) called the Recovery Accountability and Transparency
Board, which is responsible for overseeing Federal agencies to ensure that there is transparency
and accountability for the expenditure of recovery funds. For the interim period until that board
becomes operational, the President has coordinated a team from across Federal agencies to track
Recovery Act dollars and report findings on this website.
(Back to Top)
Q: I want to help. What can I do?
A: Over the course of the spring, increasing amounts of information will become available on
Recovery.gov that will show where the money is going. We are counting on you to peruse that
information and tell us what you find. Please share your stories, your ideas, and your comments.
They will then be sent to the Board for their review.
Q: How can I see how much recovery money is coming to my community?
A: Until the funding is distributed by the Federal government to states and local governments, and
eventually to your community, we won't be able to determine exactly where all of the funding will
go. Over the next few weeks and months, there's going to be a lot of data coming in, as we
coordinate with different agencies. As soon as the first dollars start to go out, you'll be able to
track where the money is going. Detailed state maps will be available to assist your tracking.
Q: What's the purpose of the new legislation?
A: The purpose of the Recovery Act is to create and save jobs, jumpstart our economy, and build
the foundation for long-term economic growth. The Act includes measures to modernize the
nation's infrastructure, enhance America's energy independence, expand educational
opportunities, increase access to health care, provide tax relief, and protect those in greatest
need.
Q: Where can I find the full text of The American Recovery and Reinvestment Act of 2009?
A: The text of the law can be found in Text or PDF format here.
Q: What type of programs will this recovery package fund?
A: The Recovery Act specifies appropriations for a wide range of Federal programs and will
increase or extend certain benefits payable under the Medicaid, unemployment compensation,
and nutrition assistance programs. The legislation also reduces individual and corporate income
tax collections and makes a variety of other changes to tax laws. The package provides funds that
will:
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Create a framework for clean, efficient, American energy;
Transform our economy with science and technology;
Modernize roads, bridges, transit and waterways;
Overhaul education for the 21st Century;
Dispense tax cuts to make work pay and create jobs;
Expand access to healthcare and lower costs;
Provide assistance to workers hurt by the economy;
Save public sector jobs and protect vital services;
(Back to Top)
Q: What will I be able to locate on Recovery.gov?
A: Federal agencies are taking in bids for recovery projects, so right now, Recovery.gov features a
summary of the funds that are allocated for different programs, as well as the responsible Federal
agencies. As Federal agencies and other recipient organizations report information about their
spending plans, we will post that information on the site. We are currently developing systems to
track the funds and report results.
Q: What’s a better way to find the information I’m looking for -- browsing or searching?
A: The website will have both functions, but for now, browsing is a better bet. As we begin to fill
the database with more data, the search function will be more useful in finding specific
information.
Q: How does Recovery.gov differ from USASpending.gov?
A: Recovery.gov tracks only the targeted investments allocated by the American Recovery and
Reinvestment Act. USASpending.gov collects data about all types of contracts, grants, loans, and
spending across government agencies.
Q: How can I contact the Administration with questions or comments about Recovery.gov and the recovery
package?
A: The best method to comment or ask a question on Recovery.gov is to use our contact us form.
The question or message will be referred to the best person to handle the matter, and they will
respond as quickly as possible.
For questions about the federal government, visit USA.gov or call 1 (800) FED INFO (1-800-3334636) (8 am-8 pm ET Monday-Friday).
Q: Is Recovery.gov accessible for people for with disabilities?
A: Recovery.gov complies with all of the automatic checkpoints of the Section 508 Accessibility
Guidelines, and has been manually verified for nearly all of the manual checkpoints.
This compliance has been tested using Watchfire WebXACT program. Because Recovery.gov uses
dynamically generated Web pages, it is not possible to test literally every page. However, each
dynamically generated output style can be tested. We plan to continue to upgrade Recovery.gov's
accessibility for individuals with disabilities in forthcoming updates.
Q: What is a fiscal year (FY)?
A: For accounting purposes, the Federal government uses a defined 12-month period as a
financial or fiscal year. The Federal fiscal year begins on October 1 and ends on September 30 of
the following calendar year. For instance, fiscal year 2009 is 10/1/2008 - 9/30/2009.
Q: Is the spending data on recovery.gov available in a format (like XML) that developers can use to create
mashups and gadgets?
A: Not at this time. But, as new systems are developed to capture the allocations and expenditures
under the Act, we plan to make that data available in exportable form.
Economic and Regulatory Policy
What IF… The Federal Government were required to Balance its Budget?
Good Times, Bad Times
Fiscal Policy
Monetary Policy
World Trade
The Politics of Taxes
The Social Security Problem
1. Graphic Organizer
2. Which Side are you on: Social Security Privatization
3. Remedy/Solutions/Possiblities/Alternatives
this chapter, they should be able to:
 Correctly define a series of basic terms used in discussions of economic policy, including
inflation, unemployment, the business cycle, recession, depression, and budget deficit.
 Explain the essential tools of fiscal policy, namely increasing the budget deficit during a
recession and reducing it during a boom.
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Describe how the Federal Reserve System implements monetary policy (increasing or
decreasing the rate of growth of the money supply).
Explain why fiscal policy may be more effective against recessions, and monetary policy
against inflation.
Identify some of the important events in the history of economic policy since World War II,
including Kennedy’s use of Keynesianism, the triggering of inflation under Johnson, Volker’s
suppression of inflation, Bill Clinton’s tax increase, and George W. Bush’s return to budget
deficits.
Define key concepts used in the discussion of world trade, including imports, exports, quotas,
and tariffs.
Understand some of the arguments economists advance in favor of free trade.
Describe the role of the WTO.
Define the current account balance and understand what happens when the balance is
negative.
Understand the concept of a marginal tax rate.
Define progressive and regressive taxes and identify which taxes fall into each category.
Understand the pay-as-you-go character of Social Security.
Describe some of the proposals that have been advanced to guarantee the survival of the
Social Security system in the future.
TOPICS FOR DISCUSSION
Some advocate the idea of the government as the “employer of last resort,” a means of obtaining
a job when no other jobs are available. What positive results might result from this system?
What impact might such a system have on the poor? Would it be beneficial to their selfesteem, or injure it?
Who benefits from inflation? Who would be hurt most by it? (Some answers are provided in
“Beyond the Book.”)
How could the nation address the problem of politicians adopting only the easier half of
Keynesian fiscal policy, that is, their willingness to reduce taxes during recessions but
reluctance to raise taxes during a boom?
Britain has recently made the Bank of England—which performs functions that in America are
performed by the Fed—politically independent of the nation’s elected leaders. In other words,
Britain has given the Bank the independence the Fed already has. Why do you think the
British may have done this?
What problems might follow from twelve European nations all adopting the same currency, the
Euro? (Hint: they will then all have the same monetary policy.)
Why are the public and the economics profession on such different wavelengths when it comes to
world trade?
How much of a problem is it that the United States has become so dependent on money borrowed
from foreign countries (the increasing current account deficit)? What might happen if
foreigners stopped lending? (Hint: we’d have to start paying the money back.)
Is progressive taxation “fair”? What arguments could be made that it is fair or unfair?
Which of the proposals advanced to “fix” Social Security have the most merit? Which would
cause the most problems?
BEYOND THE BOOK
Most people think that inflation is bad. After all, inflation means higher prices, and when we have
to pay higher prices, are we not necessarily worse off? The obvious answer, yes, is not
quite the correct one, though. The truth is that inflation affects different people differently.
Its effects also depend on whether it is anticipated or unanticipated. In most situations,
unanticipated inflation benefits borrowers because the interest rate they are being charged
does not fully compensate for the inflation that actually occurred. In other words, the
lender did not anticipate inflation correctly. Whenever inflation rates are underestimated
for the life of a loan, creditors lose and debtors gain. For example, periods of considerable
unanticipated (higher-than-anticipated) inflation occurred in the late 1960s and the early
and late 1970s. During those years, creditors lost and debtors gained.
Banks attempt to protect themselves against inflation by raising interest rates to reflect anticipated
inflation. Adjustable-rate mortgages in fact do just that: the interest rate varies according to
what happens to interest rates in the economy. Workers can protect themselves through
cost-of-living adjustments (COLAs), which are automatic increases in wage rates to take
account of increases in the price level. To the extent that you hold cash, you will lose
because of inflation. If you have put $100 in a mattress and the inflation rate is 10 percent
for the year, you will have lost 10 percent of the purchasing power of that $100. If you
have your funds in a non-interest-bearing checking account, you will suffer the same fate.
Individuals attempt to reduce the cost of holding cash by putting it into interest-bearing
accounts, many of which pay rates of interest that reflect anticipated inflation.
Some economists believe that the main cost of inflation is the cost of resources used to protect
against inflation and the distortions introduced as firms attempt to plan for the long run.
Individuals have to spend time and resources to figure out ways to cover themselves if
inflation is different from what it has been in the past. That may mean spending a longer
time working out more complicated contracts for employment, for purchases of goods in
the future, and for purchases of raw materials. Another major problem with inflation is that
it usually does not proceed perfectly evenly. Consequently, the rate of inflation is not
exactly what people anticipate. When this is so, the purchasing power of money changes in
unanticipated ways. Because money is what we use as the measuring rod of the value of
transactions we undertake, we have a more difficult time figuring out what we have really
paid for things during periods of inflation that proceed unevenly. As a result, in such
situations, resources, such as labor and capital, tend to be misallocated because people have
not really valued them accurately.
Inflation has been common during or immediately after a war. In 1980, however, the United
States experienced rates of inflation exceeding 12 percent in a time of peace. What caused
this inflation? Several factors were important. Policy errors by presidents Lyndon Johnson
(1963–1969) and Richard Nixon (1869–1974) allowed inflation to take an initial hold.
Then came the great oil price shock of the 1970s. By that decade, the United States had lost
its self-sufficiency in producing oil and was reliant on oil imports. The oil-producing
nations of the Middle East, joined together in the Organization of Petroleum Exporting
Countries (OPEC), realized that for the first time they could control the amount and price
of oil in world trade. In 1973, the United States supported Israel in a war with its
neighbors. Arab oil producers attempted to punish the United States for this support by
launching an oil embargo against it. (An embargo is a refusal to engage in international
trade.) The Arabs lifted the embargo the following year, but kept prices high. Additional
policy mistakes by President Jimmy Carter (1977–1981) let high oil prices drive up the
price of almost everything else. By the last years of Carter’s administration, the United
States was experiencing high inflation and high unemployment at the same time. Not
surprisingly, Carter lost the presidential election of 1980 to Republican candidate Ronald
Reagan.
The success of Volker’s policies in fighting inflation gave new impetus to a school of economic
thinking known as monetarism. Advocates of this philosophy oppose the use of fiscal
policy and believe that the government’s role in managing the economy should be limited
to monetary policy. Some monetarists believe that the government cannot act quickly
enough to fine-tune the economy using fiscal policy. Others argue that ultimately, fiscal
policy does not determine the course of the economy at all. The size of the money supply is
the only important long-run variable. Milton Friedman, perhaps the most famous
monetarist, advocated a non-discretionary monetary policy. Under this theory,
policymakers should increase the money supply smoothly at a rate consistent with the
economy’s long-run potential growth rate. Such a policy has not been adopted in the
United States, however. Fed chairman Greenspan has regularly employed discretionary
monetary policy to heat or cool the economy, with some success.
A nation’s particular distribution of resources often gives it an absolute advantage over another
nation in the production of one or more goods. Obviously, Colombia’s tropical climate and
relatively inexpensive labor make it ideally suited for growing coffee. Even using the same
amount of resources, a country with a moderate climate, such as Belgium, would produce
quite a bit less coffee than Colombia. We say that Colombia has an absolute advantage in
coffee production over Belgium. Often, the world can gain additional output from trade
even when a nation does not have an absolute advantage in producing the goods or services
that it exports. For example, a country may be able to produce one type of good—such as
soybeans—much more efficiently than it can produce other goods—such as cotton. In this
circumstance, the country has a comparative advantage in producing soybeans. The world
as a whole may benefit if this country produces soybeans for export even if certain other
countries can produce soybeans more cheaply. The benefit stems from the greater
efficiency enjoyed by the exporting country. By specializing in soybeans—instead of
wasting its resources by producing cotton inefficiently—the exporting nation increases its
own overall productivity. Through international trade, the world as a whole can then
benefit from the efficiency gain.
International trade also bestows benefits on countries through the transmission of ideas.
International trade has been the principal means by which new goods, services, and
processes have spread around the world. In recent years, some activists have objected to
this process, seeing it as part of a “globalization” that destroys world diversity. People
around the world, however, rarely adopt foreign ideas unless they benefit from them in
some way. For a historical example, coffee was initially grown in Arabia near the Red Sea.
Around 675 B.C., coffee began to be roasted and consumed as a beverage. Eventually, it
was exported to other parts of the world; the Dutch started cultivating it in their colonies in
the 1600s and the French in the 1700s. Consider also the lowly potato, which is native to
the Peruvian Andes. In the 1500s, it was carried to Europe by Spanish explorers.
Thereafter, its cultivation and consumption spread rapidly.
Today, we talk about international trade’s role in spreading intellectual property—ideas, patents,
inventions, software, movies, music, and the like. Virtually all of the intellectual property
used throughout the world today has been transmitted through international trade. Finally,
production processes are transmitted through international trade. For example, an
important Japanese manufacturing innovation, known as just-in-time inventory control, is
now common in U.S. factories. Rather than having large stocks of parts for manufacturing
cars and computers, firms that make these products (and others) have the necessary parts
arrive just when they are needed. This reduces the cost of holding inventories. Just-in-time
systems reduce manufacturing costs as a consequence.
Textile import quotas can serve as an example of quotas. The result of the quotas is that U.S.
consumers pay a higher price on imported textiles. In addition, they pay a higher price on
substitute domestic textiles. This benefits domestic textile producers. The U.S. textile
industry has its own import restricting organization called the Committee for
Implementation of Textile Agreements (CITA). The CITA holds no open meetings. At
times, it has placed quotas on men’s underwear from the Dominican Republic, cotton
nightwear from Jamaica, and wool coats from Honduras. The benefit from CITA quotas for
the U.S. textile industry has been estimated as high as $12 billion in additional profits each
year.
CHAPTER OUTLINE
A major economic policy issue is how to maintain stable economic growth without falling into
either excessive unemployment or inflation (rising prices). Key concept: Inflation, a sustained rise
in the general price level of goods and services.
I. Good Times, Bad Times
The U.S. economy experiences booms and busts. The busts are called recessions. Key
concept: Recession, two or more successive quarters in which the economy shrinks instead
of grows.
A. Unemployment. Political leaders have a powerful incentive to keep the rate of
unemployment down. Key concept: Full employment, an arbitrary level of
unemployment that corresponds to “normal” friction in the labor market. In 1986, a 6.5
percent rate of unemployment was considered full employment. Today, it is assumed
to be around 5 percent.
1. Unemployment Becomes an Issue. The federal government did not concern itself
with unemployment until the Great Depression of the 1930s. At the beginning of
the depression, unemployment passed 25 percent, the highest rate in U.S. history.
Since the 1930s, the federal government offers unemployment insurance as a
benefit. Not all members of the labor force are eligible for the insurance, however.
2. Measuring Unemployment. The Department of Labor and the Bureau of the
Census have competing methods of calculating unemployment. Standard figures,
however, do not include “discouraged workers” who have given up on looking for
a job.
B. Inflation. Inflation can be measured by changes in the Consumer Price Index (CPI).
Key concept: the Consumer Price Index, a measure of the change in price over time of
a specific group of goods and services used by the average household. Over time,
inflation adds up. Today’s dollar is worth about as much as a 1900 nickel.
C. The Business Cycle. Economists call the cycle of recurring booms and busts the
business cycle. An extremely severe recession is called a depression.
II. Fiscal Policy
Fiscal policy is concerned with achieving economic policy goals through changes in
spending or levels of taxation.
A. Keynesian Economics. Fiscal policy is typically based on the ideas of the British
economist John Maynard Keynes (1883–1946). Keynes believed that after falling into
a recession or depression, a modern economy may become trapped in an ongoing state
of less than full employment.
1. Government Spending. Therefore, in a recession or depression, the government
should engage in spending to make up for the spending that is not happening in the
private sector.
2. Government Borrowing. For this to work, the spending must be paid for by
borrowing, not new taxes. In other words, the government must run a budget
deficit. The borrowing undertaken by the government makes up for the borrowing
that is not happening in the private sector.
3. Discretionary Fiscal Policy. This is the discretionary—voluntary—use of fiscal
policy to fine-tune the economy. John F. Kennedy was the first president to
explicitly accept Keynesian economics, and he proposed a tax cut in line with the
theory. The tax cut proved to be a successful economic stimulus.
4. Discretionary Fiscal Policy Failures. Keynesian theory calls for reducing or
eliminating the budget deficit during boom times, the opposite of what is done
during a recession. Lyndon Johnson, Kennedy’s successor, refused to ask Congress
for tax increases to pay for the Vietnam War, at a time when the economy was
booming. The result of Johnson’s running an increased budget deficit during boom
times was to initiate a decade-and-a-half long period of substantial inflation.
B. The Thorny Problem of Timing. With fiscal policy, timing is a problem. By the time an
antirecessionary increase to the budget deficit has made it through Congress, the
country might be back in a boom.
C. Automatic Stabilizers. Some government programs work to counteract the business
cycle automatically. For example, even with no changes to the law, relatively less
income tax is collected in a recession (putting up the deficit) and relatively more is
collected in a boom (reducing the deficit). Unemployment compensation has the same
effect.
D. Deficit Spending and the Public Debt.
The government funds its deficit primarily by selling U.S. treasury bonds. Twenty
years ago, only 15 percent of these bonds were held abroad. Today the figure is nearly
50 percent.
1. The Public Debt in Perspective. Key concept: Net public debt, the accumulation of
all past federal government deficits; the total amount owed by the federal
government to individuals, businesses, and foreigners. (It does not include what
the government owes to itself.) We measure the seriousness of the net public debt
by measuring it against the gross domestic product (GDP), the dollar value of all
final goods and services produced in a one-year period.
2. Are We Always in Debt? From 1960 until the last few years of the twentieth
century, the federal government spent more than it received in all but two years.
Politicians have been happy to implement Keynesianism during recessions, but shy
away from it during booms. In 1993, however, President Bill Clinton deliberately
obtained a tax increase as the nation was entering a boom. The apparent results of
the policy were quite beneficial. From 1998 to 2002, the government actually ran a
budget surplus. Since the dot-com bust and the 2001-2002 recession, however,
George W. Bush has followed a policy of high spending and tax cuts that have
increased the budget deficit greatly.
III. Monetary Policy
Key concept: Monetary policy, the utilization of changes in the amount of money in
circulation to alter credit markets, employment, and the rate of inflation.
A. Organization of the Federal Reserve System. The Federal Reserve System, or Fed, sets
monetary policy, not the president or Congress. The key body for carrying out the
policy is the Federal Open Market Committee.
B. Loose and Tight Monetary Policies. The Fed implements policy by increasing or
reducing the rate of growth of the money supply. Increasing the rate of growth is loose
monetary policy. Reducing the rate is tight monetary policy.
C. Time Lags for Monetary Policy. Like fiscal policy, monetary policy has a problem with
time lags, but the Fed can make a policy change more quickly than Congress.
D. The Way Federal Reserve Policy is Announced. The Fed announces changes to
monetary policy by raising or lowering the federal funds rate, a government-controlled
interest rate for funds that banks borrow from each other. This interest rate actually has
little effect on the economy. The true effect of the Fed’s policy comes from controlling
the size of the money supply.
E. Monetary Policy versus Fiscal Policy. If interest rates go high enough, people will stop
borrowing and inflation will subside. Monetary policy, however, cannot force people
to borrow money in a recession. Therefore, while monetary policy is more powerful
against inflation, fiscal policy is more effective against recessions, because the
government does the borrowing itself.
IV. World Trade
While a majority of the public is skeptical of the benefits of world trade, almost all
economists of all political persuasions support it.
A. Imports and Exports. Key concepts: Imports, goods and services produced outside a
country but sold within its borders. Exports, goods and services produced domestically
for sale abroad. Imports make up about 15 percent of our consumption, and exports
make up about 13 percent of our production. While world output has increased by
about eight times since 1950, world trade has increased by more than twenty-one
times.
B. The Impact of Import Restrictions on Exports. “In the long run, imports are paid for by
exports.” If we restrict the ability of the rest of the world to sell goods and services to
us, then the rest of the world will not be able to purchase all of the goods and services
that we want to sell to them.
1. Protecting American Jobs. If imports are restricted to save American jobs, the price
of the good or service in question goes up, hurting consumers. Further, there will
be job losses in export industries.
2. Quotas and Tariffs. Imports are restricted by tariffs, or taxes on imports, or by
import quotas that restrict the value or number of items of a particular good or
service that can be imported. A severe new tariff in 1930 worsened the impact of
the Great Depression.
3. Free Trade Areas and Common Markets. Groups of nations have created alliances
to lower trade restrictions. The most important of these, once called the Common
Market, has evolved into the European Union, a confederation of states. In North
America, the North American Free Trade Association (NAFTA) reduces trade
barriers between the United States, Mexico, and Canada.
C. The World Trade Organization. The WTO seeks to lower trade barriers worldwide.
1. What the WTO Does. The WTO also has a dispute-resolution mechanism that
nations may use.
2. The WTO and Globalization. The WTO has become the focus of those who fear
the supposed dangers of globalization. It is true that neither the United States nor
any other country has a veto power within the WTO.
D. The Balance of Trade and the Current Account Balance.
Key concept: The balance of trade, or the difference between the value of a nation’s
exports of goods and its imports of goods. The U.S. balance of trade has been
significantly negative for many years.
1. The Current Account Balance. This is a broader concept than the balance of trade.
The current account balance includes the balance of trade in services, unilateral
transfers, and other items. It is also negative and has been growing more so.
2. Are We Borrowing Too Much from Other Countries? Because imports and exports
must balance, the current account deficit means that we have been exporting
dollars, or future claims on our production. Another way of looking at this is to say
that foreigners are lending us money. Is America using this money wisely? If
productively invested, the borrowed money can pay for itself. If it is merely used
for consumption, however, we have a problem.
V. The Politics of Taxes
Currently, Americans pay taxes that total to somewhat less than 30 percent of the GDP.
A. Federal Income Tax Rates. Not all of your income is taxed at the same rate. The first
few dollars you make are not taxed at all. The highest rate is imposed on the “last”
dollar you make. This highest rate is the marginal tax rate. High marginal tax rates
inspire major efforts to avoid the taxes.
B. Loopholes and Lowered Taxes. Special interests may lobby Congress for “loopholes’
that will allow them to shelter income from taxation. Loopholes make the tax system
dauntingly complex.
1. Progressive and Regressive Taxation. Key concepts: Progressive tax, a tax that
rises in percentage terms as incomes rise. Regressive tax, a tax that falls in
percentage terms as incomes rise.
2. Who Pays? Liberals tend to favor progressive taxes. Conservatives either favor
taxes that are less progressive, or even flat or regressive. The following taxes are
progressive: federal and (most) state income taxes, the federal corporate income
tax, and the estate tax. The following taxes are regressive: the Social Security tax,
the Medicare tax, state sales taxes, and the local property tax. Taken as a whole the
tax system is probably slightly progressive.
VI. The Social Security Problem
Social Security was established in 1935 with the intent of providing a type of insurance for
a large segment of the public. Employees and their employers pay a tax on a percentage of
the employees’ wages.
A. Social Security is Not a Pension Fund.
However, unlike private insurance programs where the individual insured makes
payments in to an account for his or her own policy, the money paid into the Social
Security program is used to provide benefits for people who have already retired, or
who are qualified to receive funds.
B. Workers per Retiree.
Initially for every recipient of Social Security there were forty workers paying into the
general fund—a one-to-forty ratio. Today, the ratio is more like one-to-three, and it
will get worse in future years. The ballooning cost of Medicare, however, may strain
the system even more than the cost of Social Security.
C. What Will It Take to Salvage Social Security?
1. Raise Taxes. One proposal for fixing Social Security is to raise taxes. This could
be accomplished by increasing the percentage of taxes withheld, or by eliminating
the current cap on wages on which the payroll tax is withheld. Such proposals,
however, would not provide a complete fix.
2. Other Options. Another proposal is to reduce benefit payouts. This could be done
by increasing the age of full eligibility to 70 or by imposing a means test for
benefits. Another proposal is to reform immigration policies so that more
immigrants are admitted to pay the tax.
VII. Features.
A. What If . . . The Federal Government Was Required to Balance Its Budget?
Such a change would be likely to increase the tax rates of middle-class Americans,
since this is the primary tax-paying group in the United States. It might also result in
higher taxes paid by corporations, but this would simply be passed on to consumers
with higher prices and workers with lower salaries. While spending cuts are another
means of achieving this objective, it would probably involve the elimination of
programs and services that would cause many Americans considerable pain. One of
the great misconceptions of modern politics is that by eliminating pork barrel spending
we could take great strides toward achieving a balanced budget. The reality is that
such spending, while gaining much media attention, actually comprises a small part of
our budget.
B. Politics and Trade—The High Cost of Saving U.S. Jobs.
Using the example of the “voluntary” import restrictions on automobiles, an economist
calculated that the higher price of cars cost consumers $6.5 billion a year, or $250,000
per year for each job saved.
C. Beyond Our Borders: Sending Work Overseas.
Outsourcing is essentially importing services. Service jobs, such as phone centers, can
be said to be “outsourced” abroad. However, the percentage of jobs being outsourced
is relatively small. In addition, the United States has a positive balance of trade in
services, in contrast to the state of our balance of trade in goods. More jobs are
“outsourced” to us than from us.
D. Which Side Are You On? Should Social Security Be Partially Privatized?
One proposal to reform Social Security, in the hopes of increasing the implicit rate of
return on contributions, is a partial privatization plan, whereby workers could opt to
take 2 percent of their Social Security payroll tax and invest to build their own
retirement. This would mean that people could have some control over their retirement
nest egg, but would not completely jeopardize their retirement income. There are
numerous critics of this plan. The biggest problem with it is that it diverts funds that
would be paid to today’s retirees. Keeping our promise to the currently retired plus
adding a privatized system could actually cost vast sums of money, forcing up taxes.
How the stimulus bill affects you
The $787 billion package might cut your taxes, make your health insurance cheaper, fix the roads you drive on
and keep the best teachers in your children's schools. And that's just for starters.
[Related content: Barack Obama, economy, education, energy, recession]
By The Associated Press
Here's an examination of how the economic stimulus plan will affect Americans.
Taxes
The recovery package has tax breaks for families that send a child to college, purchase a new car, buy a first
home or make the one they own more energy efficient.
Millions of workers can expect to see about $13 extra in their weekly paychecks, starting around June, from a new
$400 tax credit to be doled out through the rest of the year. Couples would get up to $800. In 2010, the credit
would be about $7.70 a week, if it is spread over the entire year.
A $1,000 child tax credit would be extended to more low-income families that don't make enough money to pay
income taxes, and poor families with three or more children will get an expanded earned income tax credit.
Middle-income and wealthy taxpayers will be spared from paying the alternative minimum tax, which was
designed 40 years ago to make sure wealthy taxpayers paid at least some tax but was never indexed for inflation.
Congress fixes it each year, usually in the fall.
Talk back: How will you use your tax refund?
First-time homebuyers who purchase their homes before Dec. 1 will be eligible for an $8,000 tax credit, and
people who buy new cars before the end of the year can write off the sales taxes.
Homeowners who add energy-efficient windows, furnaces and air conditioners can get a tax credit to cover 30%
of the costs, up to a total of $1,500. College students -- or their parents -- are eligible for tax credits of up to
$2,500 to help pay tuition and related expenses in 2009 and 2010.
Those receiving unemployment benefits this year won't owe federal income taxes on the first $2,400 they receive.
Health insurance
Many workers who lose their health insurance when they lose their jobs will find it cheaper to keep that coverage
while they look for work.
Right now, most people who work for medium or large employers can continue their coverage for 18 months
under the COBRA program (named for the Consolidated Omnibus Budget Reconciliation Act) when they lose their
jobs. The coverage is expensive, often more than $1,000 a month, because the newly unemployed pay the share
of premiums once covered by their employer as well as their own share from the old group plan.
Under the stimulus package, the government will pick up 65% of the total cost of that premium for the first nine
months.
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Lawmakers initially proposed also helping workers from small companies who don't generally qualify for COBRA
coverage. But that fell through. The idea was to have Washington pay to extend Medicaid to that group.
COBRA applies to group plans at companies employing at least 20 people. The subsidies will be offered to those
who lost their jobs from Sept. 1, 2008, to the end of 2009.
Those who were put out of work after September but didn't elect to have COBRA coverage at the time will have
60 days to sign up.
The plan also offers $87 billion to help states administer Medicaid. That could slow or reverse some of the steps
states have taken to cut the program.
Infrastructure
Highways repaved for the first time in decades. Century-old waterlines dug up and replaced with new pipes. Aging
bridges, stressed under the weight of today's SUVs, reinforced with fresh steel and concrete.
But the $90 billion is a mere down payment on what's needed to repair and improve the country's physical
backbone. And not all economists agree it's an effective way to add jobs in the long term, or to stimulate the
economy.
Energy
Homeowners looking to save energy, makers of solar panels and wind turbines, and companies hoping to bring
the electric grid into the computer age all stand to reap major benefits.
The package contains more than $42 billion in energy-related investments, from tax credits for homeowners to
loan guarantees for renewable energy projects and direct government grants for makers of wind turbines and
next-generation batteries.
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Profit from the stimulus plan
How can investors make money from the economic stimulus legislation? A CNBC panel of investment pros spots
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There's a 30% tax credit of up to $1,500 for the purchase of high-efficiency residential air conditioners, heat
pumps and furnaces. The credit also can be used by homeowners to replace drafty windows or put more insulation
into the attic. About $300 million would go for rebates to get people to buy more efficient appliances.
The package includes $20 billion aimed at "green" jobs to make wind turbines and solar panels and to improve
energy efficiency in schools and federal buildings. It includes $6 billion in loan guarantees for renewable energy
projects, as well as tax breaks and direct grants covering 30% of wind and solar energy investments. An additional
$5 billion is marked to help low-income homeowners make energy improvements.
About $11 billion goes to modernizing and expanding the nation's electric power grid and $2 billion to spur
research into batteries for future electric cars.
Schools
A main goal of education spending in the stimulus bill is to help keep teachers on the job.
Nearly 600,000 jobs in elementary and secondary schools could be eliminated by state budget cuts over the next
three years, according to a study released last week by the University of Washington. Fewer teachers mean bigger
classes, something that districts are scrambling to prevent.
The stimulus sets up a $54 billion fund to help prevent or restore state budget cuts, of which $39 billion must go
toward kindergarten through 12th grade and higher education. In addition, about $8 billion of the fund could be
used for other priorities, including modernization and renovation of schools and colleges, though how much is
unclear, because Congress decided not to specify a dollar figure.
The Education Department will distribute the money as quickly as it can over the next couple of years.
And it adds $25 billion extra to No Child Left Behind and special education programs, which help pay teacher
salaries, among other things.
This money may go out much more slowly; states have five years to spend the dollars, and they have a history of
spending them slowly. In fact, states don't spend all the money; they return nearly $100 million to the federal
treasury every year.
The stimulus bill also includes more than $4 billion for Head Start early education programs and for child care
programs.
National debt
One thing about the president's $790 billion stimulus package is certain: It will jack up the federal debt.
Whether or not it succeeds in producing jobs and taming the recession, tomorrow's taxpayers will end up footing
the bill.
Forecasters expect the 2009 deficit -- for the budget year that began Oct. 1, 2008 -- to hit $1.6 trillion, including
new stimulus and bank-bailout spending. That's about three times last year's shortfall.
The torrents of red ink are being fed by rising federal spending and falling tax revenues from hard-hit businesses
and individuals.
The national debt -- the sum of money owed by all levels of government -- stands at $10.7 trillion, or about
$36,000 for every man, woman and child in the U.S.
Interest payments alone on the national debt will near $500 billion this year. It's already the fourth-largest federal
expenditure, after Medicare-Medicaid, Social Security and defense.
This will affect us all directly for years, as well as our children and possibly grandchildren, in higher taxes and
probably reduced government services. It will also force continued government borrowing, increasingly from
China, Japan, Britain, Saudi Arabia and other creditors.
Environment
The package includes $9.2 billion for environmental projects at the Interior Department and the Environmental
Protection Agency. The money would be used to shutter abandoned mines on public lands, help local governments
protect drinking water supplies, and erect energy-efficient visitor centers at wildlife refuges and national parks.
The Interior Department estimates that its portion of the work would generate about 100,000 jobs in the next two
years.
Yet the plan will make only a dent in the backlog of cleanup projects facing the EPA and in the long list of chores
at the country's national parks, refuges and other public lands.

Talk back: How will you use your tax refund?
The plan sets aside $735 million for road repairs and maintenance at national parks. But that's just a fraction of
the $9 billion worth of work waiting for funding.
At the EPA, the payout is $7.2 billion. The bulk of the money will help local communities and states repair and
improve drinking water systems and fund projects that protect bays, rivers and other waterways used as sources
of drinking water.
The rest of the EPA's cut -- $800 million -- will be used to clean up leaky gasoline storage tanks and the nation's
hazardous waste sites.
Police
The stimulus bill includes plenty of green for those wearing blue.
The compromise bill doles out more than $3.7 billion for police programs, much of which is set aside for hiring
new officers.
The law allocates $2 billion for the Byrne Justice Assistance Grant, a program that has funded drug task forces and
such things as prisoner-rehabilitation and after-school programs.
An additional $1 billion is set aside to hire local police under the Community Oriented Policing Services program.
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The program, known as COPS grants, paid the salaries of many local police officers and was a "modest
contributor" to the decline in crime in the 1990s, according to a 2005 government oversight report.
Both programs had been eliminated during the Bush administration.
The bill also includes $225 million for general criminal justice grants for programs such as youth mentoring, $225
million for Indian tribe law enforcement, $125 million for police in rural areas, $100 million for victims of crimes,
$50 million to fight Internet crimes against children and $40 million in grants for law enforcement along the
Mexican border.
Higher education
The maximum Pell Grant, which helps the lowest-income students attend college, will increase from its current
limit of $4,731 to $5,350 starting July 1 and to $5,550 in 2010-11. That ill cover three-quarters of the average cost
of a four-year college. An additional 800,000 students, for a total of about 7 million, should now qualify for Pell
funding.
The stimulus also increases the tuition tax credit to $2,500 and makes it 40% refundable, so families that don't
earn enough to pay income tax can still get up to $1,000 in extra tuition help.
In addition, computer expenses will now be an allowable expense for 529 college savings plans.
The final package cut $6 billion the House wanted to spend to kick-start building projects on college campuses.
But parts of the $54 billion state stabilization fund -- with $39 billion set aside for education -- can be used for
modernizing those facilities.
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Profit from the stimulus plan
How can investors make money from the economic stimulus legislation? A CNBC panel of investment pros spots
potential winners and losers. (Feb. 13)
There's also an estimated $15 billion for scientific research, much of which will go to universities. Funding for the
National Institutes of Health includes $1.5 billion set aside for university research facilities.
Altogether, the package spends an estimated $32 billion on higher education.
The poor
More than 37 million Americans live in poverty, and the vast majority of the poor are in line for extra help under
the giant stimulus package. Millions more could be kept from slipping into poverty by the economic lifeline.
People who get food stamps -- 30 million and growing -- will get more. People drawing unemployment checks -nearly 5 million and growing -- would get an extra $25, and keep those checks coming longer. People who get
Supplemental Security Income -- 7 million poor Americans who are elderly, blind or disabled -- would get a onetime extra payment of $250.
Many low-income Americans also are likely to benefit from a trifecta of tax credits: expansions to the existing child
tax credit and Earned Income Tax Credit, and a new refundable tax credit for workers. Taken together, the three
credits are expected to keep more than 2 million Americans from falling into poverty, including more than 800,000
children, according to the private Center on Budget and Policy Priorities.
The package also includes a $3 billion emergency fund to provide temporary assistance to needy families. In
addition, cash-strapped states will get an infusion of $87 billion for Medicaid, the government health program for
poor people, which should help avoid cuts to benefits for the needy.
Obama Outlines Plan To Slash 'Wasteful' Spending
by Deborah Tedford
Gerald Herbert
Sen. John McCain (R-AZ) looks on as President Obama makes remarks
Wednesday about White House proposals to overhaul the way the government
solicits contracts. AP
NPR.org, March 4, 2009 · President Obama signed a directive Wednesday that
changes the way government contracts are awarded and who can get them, a
move he said could save as much as $40 billion a year.
The amount the government spends on contracting has ballooned over the past
eight years, with outlays for goods and services increasing from $200 billion in
2000 to more than $500 billion in 2008. The president said his plan would make
the contracting process more competitive and accessible to independent
contractors — and more difficult for contractors to defraud taxpayers.
"It's time for this waste and inefficiency to end," the president said Wednesday
morning at the White House. "It's time to invest only in what works."
Obama said his administration would stop hiring private contractors to perform
work that government employees could handle. In addition, he pledged to open
the process to small businesses and eliminate "unnecessary" no-bid contracts.
The plan also strengthens oversight of contracts to cut overruns and fraud.
White House Budget Director Peter Orszag and Cabinet officials will have new
guidelines for contracting ready by the end of September, Obama pledged.
On the hot topic of defense spending, the president said he would draw a line
between spending that keeps Americans safe and money that largely enriches
defense contractors.
Last year, a Government Accountability Office study of 95 major defense
acquisitions projects found cost overruns of 26 percent, totaling $295 billion over
the life of the projects. Obama said investing in proven technologies and
increasing oversight would make the defense contracting system more efficient.
Cost overruns on defense contracts came up last week at the White House
summit on the economy, when Arizona Sen. John McCain used the president's
fleet of Marine One helicopters as an example. Obama said he had already spoken
to Defense Secretary Robert Gates about the fleet of 28 helicopters costing $11.2
billion over budget.
Obama also endorsed a bipartisan effort by McCain and Sen. Carl Levin (D-MI)
to change defense procurement and asked Gates to work with the two on
legislation that would end the cost overruns common in defense projects.
"The days of giving defense contractors a blank check are over," Obama said.