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Economic Policy
After seven years as president, George W.
Bush appeared to be presiding over an almost
unprecedented economic boom. For fifty-two
straight months, the number of jobs available
in the United States grew, and unemployment
averaged only 5.2 percent. National debt—
except for that incurred by the Iraq War—
was relatively low, and the gross domestic
product was rising. Housing investments,
too, were gaining value at tremendous rates.
But, below the surface were some troubling
signs. An influx of competitively priced goods
led many U.S. companies to relocate factories
to nations with lower production costs, such
as Mexico, China, India, and Pakistan. These
and other relocations had a destabilizing
effect on domestic industry. In addition, the
economic boom had produced a huge demand
for housing, fueled in part by low interest
rates. High-risk (subprime) mortgages were
extended to first-time homebuyers and others
living beyond their means. And, with
568
economic optimism running high, personal
savings rates declined to historic lows, while
personal debt rose.
The collusion of these forces soon had
negative consequences for even the best of
economic indicators. In 2008, approximately
2.6 million people lost their jobs, as large
companies downsized and many smaller
companies struggled to stay in business.
Oil and other commodity prices began to
rise rapidly—gasoline prices reached four
and even five dollars per gallon in some
jurisdictions. These forces combined to push
the housing market, the unstable debt markets,
and the broader economy—both at home and
abroad—into crisis.
Realizing the severity of the economic
situation, in February 2008, the Bush
administration, along with Congress,
announced a $168 billion federal stimulus
package to provide Americans with tax rebates
and relief intended to help boost consumer
The government often takes a prominent role in stimulating the economy. At left, John Maynard Keynes, the
father of modern macroeconomic theory, which favors government spending to promote economic growth,
speaks at a conference in the 1940s. At right, a sign advertises a road construction project funded by the 2009
American Recovery and Reinvestment Act, an example of Keynesian economics.
demand and reduce economic hardship.
But, these efforts were insufficient, and the
financial meltdown worsened. The collapse
of many financial institutions as a result of
the subprime mortgage crisis in September
2008 led Congress to pass the Temporary
Assets Relief Program (TARP), an approximately
$700 billion bailout of the financial industry.
Although these efforts took great strides
to preserve American savings and loan
companies, they did little to help average
citizens. To address these concerns, in
February 2009, President Barack Obama
signed the $787 billion American Recovery
and Reinvestment Act, designed to cut taxes
and create jobs through deficit spending.
Among the programs funded by the Recovery
Act were road and bridge construction
projects, scientific research, and the expansion
of Internet access to underserved populations.
Despite these efforts, economic recovery
for many individual Americans continues to be
slow. By November 2010, unemployment
hovered around 10 percent nationally, and the
Democratic Party paid the consequences at the
ballot box.
Still, it is clear that government has played
an important role in helping capitalism recover
from its shortcomings.
What Should I Know About . . .
After reading this chapter, you should be able to:
18.1 Trace the evolution of economic policy in the
United States, p. 570.
18.2 Assess the impact of the budget process on fiscal
policy, p. 577.
18.3 Analyze the effect of the Federal Reserve System
on monetary policy, p. 583.
18.4 Describe the evolution of income security policy
in the United States, p. 586.
18.5 Evaluate the role of fiscal, monetary, and income
security policy in the economic recession and
recovery, p. 593.
569
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CHAPTER 18
Economic Policy
T
he U.S. economic system is a mixed free-enterprise system characterized
by private ownership of property, private enterprise, and marketplace competition. But, the national government has long played an important role
in fostering economic development through its tariffs (taxes on imported
goods), tax policies, the use of public lands, and the creation of a national bank.
More recently, the government has also become involved in social regulations that
affect the economy, such as income security policies.
With this greater involvement comes debate over the proper role of the government in the economic sector. Those favoring limited government participation are
pitted against others who believe the government is responsible for managing the
economy through policy. In this chapter, we will consider both of those viewpoints
as we describe the policies the government uses to achieve its economic goals.
In this chapter, we will explore the following topics:
■
First, we will examine the roots of economic policy.
■
Second, we will investigate fiscal policy, including its foundations, the impact
of globalization, and the budget process.
■
Third, we will look at the elements of monetary policy, including the Federal
Reserve System.
■
Fourth, we will trace the evolution of income security policy from its
foundations to today.
■
Finally, we will assess the recession and economic recovery as it relates to
fiscal, monetary, and income security policies.
ROOTS OF Economic Policy
18.1 . . . Trace the evolution of economic policy in the United States.
The government’s role in regulating the economy has evolved over our nation’s history. During the nineteenth century, the national government defined its economic
role narrowly, although it did collect tariffs, fund public improvements, and encourage
private development. The national government increased its involvement in economic
regulation during the Progressive and New Deal eras. In more recent years, it has
turned its attention to social regulation and deregulation.
The Nineteenth Century
laissez-faire
A French term meaning “to allow to
do, to leave alone.” It holds that
active governmental involvement in
the economy is wrong.
For much of the nineteenth century, the national government subscribed to a laissezfaire (literally “to allow to do” or “to leave alone”) economic philosophy. The laissez-faire
economic system holds that active governmental involvement in the economy is wrong,
and that the role of government should be limited to the maintenance of order and justice, the conduct of foreign affairs, and the provision of necessary public works. As a
result, most of the national intervention in the economy during this time amounted to
setting and adjusting tariffs and maintaining the liberty necessary to fuel economic fires.
But, the Civil War and the growing industrialization of the postwar economy brought
changes to the political landscape. Industrialization, for example, led to industrial accidents
and disease, labor–management conflicts, unemployment, and the emergence of huge
corporations that could exploit workers and consumers. Industrialization also worsened
Roots of Economic Policy
Photo courtesy: Joseph Keppler/Bettmann/Corbis
What was public sentiment toward big business in the late 1800s? Here, a political cartoonist
depicts the perception that the U.S. Senate was dominated by various trusts in the nineteenth
century.
the effects of natural business cycles, or fluctuations between periods of economic growth
and recession (or periods of boom and bust).
The first major government effort to regulate business was caused by growing concern over the power of the railroads. After nearly two decades of pressure from farmers,
owners of small businesses, and reformers in the cities, Congress adopted the Interstate
Commerce Act in 1887. Enforced by the new Interstate Commerce Commission
(ICC), the act required that railroad rates should be “just and reasonable.”1 The act also
prohibited such practices as pooling (rate agreements), rate discrimination, and charging
more for a short haul than for a long haul of goods.
Three years later, Congress dealt with the problem of trusts, the name given to
large-scale, monopolistic businesses that dominated many industries, including oil,
sugar, whiskey, salt, and meatpacking. The Sherman Anti-Trust Act of 1890 prohibited all restraints of trade, including price-fixing, bid-rigging, and market allocation
agreements. It also prohibited all monopolization or attempts to monopolize, including domination of a market by one company or a few companies.
The Progressive Era
The Progressive movement drew much of its support from the middle class and
sought to reform America’s political, economic, and social systems. There was a desire
to bring corporate power under the control of government and make it more responsive to democratic ends. Progressive administrations under Presidents Theodore
Roosevelt and Woodrow Wilson established or strengthened regulatory programs to
protect consumers and to control railroads, business, and banking.
The Pure Food and Drug Act and the Meat Inspection Act, both enacted in
1906, marked the beginning of consumer protection as a major responsibility of the
national government. These laws prohibited adulteration and mislabeling of food and
drugs and set sanitary standards for the food industry.
To control banking and regulate business, Congress passed three acts. The Federal
Reserve Act (1913) created the Federal Reserve System to regulate the national banking system and to provide for flexibility in the money supply in order to better meet
business cycles
Fluctuations between periods of
economic growth and recession,
or periods of boom and bust.
571
TIMELINE: Regulating the Economy
1887 Interstate Commerce
Act—This early government effort
to regulate business establishes
the Interstate Commerce Commission and allows the government
to regulate railroad rates.
1906 Meat Inspection
Act—The Meat Inspection
Act, along with the Pure
Food and Drug Act, typifies
Progressive era reforms.
1913 Sixteenth
Amendment—The Amendment allows the national
government to begin to
collect an income tax.
1890 Sherman Anti-Trust
Act—The act allows
government to begin to deal
with the growing number of
monopolies forming in
American business.
How did the Progressive era change government regulation of the
economy? During this era, the national government began to pass work-
Photo courtesy: Reproduced from the Collections of the Library of Congress
place and product safety measures such as the Meat Inspection Act.
572
commercial needs and combat financial panics.
Passage of the Federal Trade Commission (FTC)
Act and Clayton Act of 1914 strengthened anti-trust
policy. These statutes, like the Sherman Anti-Trust
Act, sought to prevent businesses from forming
monopolies or trusts.
As the national government’s functions expanded
in the late nineteenth and early twentieth centuries, fiscal
constraints forced public officials to focus on new ways
to raise federal revenue. Congress attempted to enact an
income tax, but in 1895, the Supreme Court held that
such a tax was unconstitutional.2 Consequently, the
Sixteenth Amendment to the Constitution was
adopted in 1913. The Sixteenth Amendment authorized the national government “to lay and collect taxes
on incomes, from whatever source derived” without
being apportioned among the states. Personal and corporate income taxes have since become the national
government’s major source of general revenues.
The Great Depression
and the New Deal
During the 1920s, the economy grew at a rapid pace,
and many Americans assumed that the resulting
prosperity would last forever. But, “forever” came to
1933 New Deal—
Franklin D. Roosevelt’s
New Deal increases
government intervention
in a number of economic
policy areas, including
financial markets, agriculture, labor, and industry.
1978 Airline Deregulation Act—
The act deregulates commercial
airlines; its results have been
mixed and have raised questions
about reregulation.
1964 Social Regulation
Era—During the 1960s and
1970s, the government expands
regulations on health, safety,
and environmental protection.
2008 Emergency Economic
Stabilization Act—Popularly
known as the “bailout bill,” this
act is the earliest government
response to the subprime
mortgage crisis and establishes the
Troubled Assets Relief Program
(TARP).
an end in October 1929, when the stock market collapsed and the catastrophic worldwide economic decline known as the Great Depression set in. Although the Depression was worldwide in scope, the United States was especially hard hit. All sectors of
the economy suffered, and no economic group or social class was spared.
Initially, the Herbert Hoover administration declared that the economy was fundamentally sound, a claim few believed. Investors, businesspeople, and others lost confidence in the economy. Prices dropped, production declined, and unemployment rose.
According to Bureau of Labor Statistics estimates, about one-fourth of the civilian
workforce was unemployed in 1933.3 Many other people worked only part-time or at
jobs below their skill levels. The economic distress produced by the Great Depression,
which lasted for a decade, was unparalleled before or since that time.
The Depression and President Franklin D. Roosevelt’s New Deal marked a major
turning point in U.S. economic history. During the 1930s, the laissez-faire state was
replaced with an interventionist state, in which the government took an active role
in guiding and regulating the private economy. The New Deal, for example, established reforms in almost every area, including finance, agriculture, labor, and industry.
FINANCIAL REFORMS
The first actions of the New Deal were directed at reviving
and reforming the nation’s financial system. Because of bad investments and poor
management, many banks failed in the early 1930s. To restore confidence in the
banks, Roosevelt declared a bank holiday the day after he was inaugurated, closing all
of the nation’s banks. On the basis of emergency legislation passed by Congress, only
financially sound banks were permitted to reopen. Many unsound banks were closed
for good and their depositors paid off.
Major New Deal banking laws included the Glass-Steagall Act (1933). The
Glass-Steagall Act required the separation of commercial and investment banking and
set up the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits,
interventionist state
Alternative to the laissez-faire state;
the government took an active role
in guiding and regulating the private
economy.
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Economic Policy
originally for $5,000 per account. Legislation was also passed to control abuses in the
stock markets. The Securities Act (1933) required that prospective investors be given
full and accurate information about the stocks or securities being offered to them. The
Securities Exchange Act (1934) created the Securities and Exchange Commission
(SEC), an independent regulatory commission. The SEC was authorized to regulate
the stock exchanges, enforce the Securities Act, and reduce the number of stocks
bought on margin (that is, with borrowed money).
AGRICULTURE
American agriculture had struggled even during the prosperous
1920s. The Great Depression only worsened this state of affairs. To protect this
important industry, Congress and FDR adopted a number of public policies. The
most notable of these was the Second Agricultural Adjustment Act (AAA), enacted
in 1938, after the Supreme Court declared the first AAA unconstitutional.
The second AAA provided subsidies to farmers raising crops such as corn, cotton, and wheat who grew no more than their allotted acreage. Direct payments and
commodity loans were also available from the government to participating farmers.
The Supreme Court upheld the constitutionality of the second AAA, finding it an
appropriate exercise of Congress’s power to regulate interstate commerce.4
LABOR The fortunes of labor unions, which were strong supporters of the New
Deal, improved significantly in 1935 when Congress passed the National Labor Relations Act. Better known as the Wagner Act after its sponsor, Senator Robert Wagner
(D–NY ), this statute guaranteed workers’ rights to organize and bargain collectively
through unions of their own choosing. The act prohibited a series of “unfair labor
practices,” such as discriminating against employees because of their union activities.
The National Labor Relations Board (NLRB) was created to carry out the act and to
conduct elections to determine which union, if any, employees wanted to represent
them. Unions prospered under the protection provided by the Wagner Act.
What does the National Labor Relations Board (NLRB) do? The NLRB works to enforce the
Wagner Act and help adjudicate issues of union representation. Here, the NLRB holds a hearing
in Pennsylvania in 1937 to consider alleged abuses of the Bethlehem Steel Corporation.
Photo courtesy: Bettmann/Corbis
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Roots of Economic Policy
575
Another important piece of New Deal legislation designed to protect the rights
of laborers was the Fair Labor Standards Act (FLSA). The act set minimum wage and
maximum hours requirements at twenty-five cents per hour and forty-four hours per
week, respectively. The act also banned child labor. The FLSA did not cover all
employees, however; it exempted farm workers, domestic workers, and fishermen.
INDUSTRY REGULATIONS
During the New Deal, Congress established new or
expanded regulatory programs for several industries. The Federal Communications
Commission (FCC), created in 1934 to replace the old Federal Radio Commission,
was given extensive jurisdiction over the radio, telephone, and telegraph industries.
The Civil Aeronautics Board (CAB) was put in place in 1938 to regulate the commercial aviation industry. The Motor Carrier Act of 1935 put the trucking industry
under the jurisdiction of the Interstate Commerce Commission (ICC). Like railroad
regulation, the regulation of industries such as trucking and commercial aviation
extended to such matters as entry into the business, routes of service, and rates. To a
substantial extent, government regulation, as a protector of the public interest,
replaced competition in these industries. Supporters of these programs believed they
were necessary to prevent destructive or excessive competition. Critics warned that
limiting competition resulted in users having to pay more for the services.
THE LEGACY OF THE NEW DEAL ERA
Just as World War I brought down the
curtain on the Progressive era, the outbreak of World War II diverted Americans’
attention from domestic reform and brought an end to the New Deal era. Many of the
New Deal programs, however, became permanent parts of the American public policy
landscape. Moreover, the New Deal established the legitimacy and viability of national
governmental intervention in the economy. Passive government was replaced with
activist government.
Social Regulation
Most of the regulatory programs established through the 1950s fell into the category
of economic regulations, government regulations of business practices, industry rates,
routes, or areas served by particular industries. From the mid-1960s to the mid-1970s,
however, the national government passed social regulations affecting consumer protection, health and safety, and environmental protection.
The government set up several major new regulatory agencies to implement these
new social regulations. These agencies included the Consumer Product Safety Commission, the Occupational Safety and Health Administration (OSHA), the Environmental
Protection Agency (EPA), the Mining Enforcement and Safety Administration, and the
National Transportation Safety Administration (see chapter 9).
The social regulatory statutes took various forms. Some had specific targets and
goals, such as the Egg Product Inspection Act and the Lead-Based Paint Poison
Prevention Act. Others were loaded with specific instructions and deadlines for the
administering agency. Examples are the Clean Air Act of 1970 (see chapter 17) and
the Employee Retirement Income Security Act of 1974 (intended to protect workers’ pensions provided by private employers). Other statutes conferred broad substantive discretion on the implementing agency. Thus, the Occupational Safety and
Health Act guarantees workers a safe and healthful workplace, but it contains no
health and safety standards with which workplaces must comply. These standards
are set through rule-making proceedings conducted by the Occupational Safety and
Health Administration, which also has responsibility for their enforcement.
As a consequence of this flood of social regulation, many industries that previously had limited dealings with government found they now had to comply with government regulation in the conduct of their operations. For example, the automobile
industry, which previously had been lightly touched by anti-trust, labor relations, and
economic regulation
Government regulation of business
practices, industry rates, routes, or
areas serviced by particular
industries.
social regulation
Government regulation of consumer
protection, health and safety, and
environmental protection.
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Economic Policy
other general statutes, found that its
products were now affected by motor
creates and enforces workplace safety standards. Here, inspectors probe working convehicle emissions standards and federditions at a California citrus grove.
ally mandated safety standards.
Why the surge of social regulation? There are four major reasons. 5
First, the late 1960s and early 1970s
were a time of social activism; the consumer and environmental movements
were at the peak of their influence.
Public interest groups such as the
Consumers Union, Common Cause,
the Environmental Defense Fund,
the Sierra Club, and Ralph Nader’s
numerous organizations were effective
voices for consumer, environmental,
and other programs (see chapter 16).
Second, the public had become
much more aware of the dangers to
health, safety, and the environment
associated with various modern products. There was, noted one observer, “a level of public consciousness about environmental, consumer, and occupational hazards that appears to be of a different order of
magnitude from public outrage over such issues during both the Progressive era and
the New Deal.”6
Third, members of Congress saw the advocacy of social regulation as a way to
gain visibility and national prominence and thus to enhance their election prospects.
Fourth, the presidents in office during most of this period—Democrat Lyndon B.
Johnson and Republican Richard M. Nixon—each gave support to the social regulation movement. For them, it was good politics to be in favor of health, safety, and environmental legislation.
Photo courtesy: Zuma/Newscom
What does the Occupational Safety and Health Administration (OSHA) do? OSHA
Deregulation
deregulation
A reduction in market controls (such
as price fixing, subsidies, or controls
on who can enter the field) in favor
of market-based competition.
In the mid-1970s, President Gerald R. Ford, seeing regulation as one cause of the
high inflation that existed at the time, decided to make deregulation, a reduction in
market controls in favor of market-based competition, a major objective of his administration. Deregulation was also a high priority for Ford’s successor, President Jimmy
Carter, who supported deregulated commercial airlines, railroads, motor carriers, and
financial institutions. All successive presidents have encouraged some degree of deregulation, though the effects of deregulation have been mixed, as illustrated by the
airline and agricultural sectors.
The Airline Deregulation Act of 1978, for example, completely eliminated
economic regulation of commercial airlines over several years. Although many new
passenger carriers flocked into the industry when barriers to entry were first
removed, they were unable to compete successfully with the existing major airlines.
Consequently, there are now fewer major carriers than under the regulatory regime.
Competition has lowered some passenger rates, but there is disagreement as to the
extent to which passengers have benefited. For example, since enactment of the
Airline Deregulation Act, small communities across the United States have lost
service as airlines make major cuts in their routes, despite government subsidies to
help maintain service.7
In spite of this mixed record, economic deregulation and reregulation have continued to receive a great deal of attention from citizens and politicians. In the 1980s
Fiscal Policy
577
Photo courtesy: Used with the permission of Dwane Powell and Creators Syndicate.
All rights reserved.
How do agriculture subsidies regulate the economy? Subsidies are government funds paid to
farmers to grow—or not grow—particular crops. They have fallen under fire in recent years
because they disproportionately benefit the wealthiest farmers.
and 1990s, agricultural price support programs came under increasing attack from
conservatives, who claimed that such government price supports promoted inefficiency.
In 1996, congressional Republicans passed a landmark agriculture bill with the aim of
phasing out crop subsidies and making prices more dependent upon the workings of
the free market. But five years later, the 2002 farm bill actually increased agricultural
subsidies by 70 percent as part of a ten-year, $180 billion package. The political pressure coming from large-scale farms and agribusinesses was obvious. According to one
analyst, “Nearly three-quarters of these funds will go to the wealthiest 10 percent of
farmers—most of whom earn more than $250,000 per year.”8
Fiscal Policy
18.2 . . . Assess the impact of the budget process on fiscal policy.
Fiscal policy is the deliberate use of the national government’s taxing and spending
policies to maintain economic stability. The president and Congress formulate fiscal
policy and conduct it through the federal budget process. The powerful instruments
of fiscal policy are budget surpluses and deficits. These are achieved by manipulating
the overall or “aggregate” levels of revenue and expenditures.
The Foundations of Fiscal Policy
The first significant contemporary application of fiscal policy occurred in the early
1960s. President John F. Kennedy, a Democrat committed to getting the country
moving again, brought economists to Washington, D.C., who believed that
increased government spending, even at the expense of an increase in the budget
fiscal policy
The deliberate use of the national government’s taxing and spending policies
to maintain economic stability.
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CHAPTER 18
Economic Policy
deficit, was needed to achieve full employment. This thinking is consistent
with Keynesian economics, which contends that government intervention is often
necessary to resolve the inefficiencies of the private sector. Many conservatives,
however, opposed budget deficits as bad public policy. To appease these critics, the
president’s advisers decided that many Americans would find deficits less objectionable if they were achieved by cutting taxes rather than by increasing government
spending.
The result was the adoption of the Revenue Act of 1964, which was signed into
law by President Lyndon B. Johnson. The act reduced personal and corporate income
tax rates. The tax-cut stimulus contributed to the expansion of the economy through
the remainder of the 1960s and reduced the unemployment rate to less than 4 percent, its lowest peacetime rate and what many people then considered to be full
employment.9 President Ronald Reagan in 1981 and President George W. Bush in
2001 and 2003 followed a similar philosophy, pushing tax cuts through Congress in
part to stimulate faltering economies.
Fiscal Policy in a Global Context
Advances in transportation, communication, and technology have strengthened the
links between the United States and the rest of the world and expanded free trade. As
a result, international affairs influence business decisions of American companies that wish to reduce labor
costs as well as expand their markets. Thus, globalization has fundamentally changed American fiscal policy. A number of analysts have warned of the dangers
of increased globalization for fiscal policy, both in the
United States and internationally. Globalization, for
Industrialization in China
example, may affect income levels for American workers. It also increases international interdependence,
The growth of the Chinese economy, especially over the last sevwhich causes one country’s economy to be affected by
eral decades, has been tremendous. A large population and low
fluctuations in other nations.
labor costs, coupled with relaxed trade barriers in a post–Cold
War economy, have aided in this growth. Economists now
estimate that by the year 2035, China’s gross domestic product
will equal that of the United States.
China’s emergence as a major economic power has not been
without cost. Rapid and unregulated industrialization has created
unprecedented environmental degradation. Yet, China—unlike
Japan and many European countries—has declined to use fiscal
policy to help limit these environmental consequences. As a result,
pollution has made cancer China’s leading cause of death. Severe
water shortages have turned farmland into desert, many citizens
lack access to safe drinking water, and much of the coastline is so
swamped by algal red tides that large sections of the ocean no
longer sustain marine life.
■
What other factors might have contributed to China’s rapid
economic growth over the last several decades?
■
Is it possible for a large country such as China to maintain
strong economic growth while improving its environmental
track record? If not, why not? If so, how?
■
What types of government policies work best to regulate
unwanted outcomes, such as pollution, food contamination,
and unsafe consumer products?
GLOBALIZATION AND INCOME Loss of real, or
inflation-adjusted, income has become a serious concern in the United States. In September 1997, the
national minimum wage was $5.15. After a series of
increases it sat at $7.25 in 2010. Despite these
increases, Americans make less today than they did in
the 1960s and 1970s. Moreover, even for people who
are working full-time, these earnings are not enough to
support a family—they are not what economists call a
“living wage.” Although this value varies widely across
the country based on localized cost of living, the average living wage in the United States far outpaces the
minimum wage. (To learn more about real and inflation adjusted wages, see Figure 18.1.)
To address the shortfalls between the national
minimum wage and a living wage, many states and
localities have adopted minimum wages that are higher
than the rate set by the federal government. Baltimore,
Maryland, for example, was the first city in the country to require that the minimum wage equal a living
wage. Although such an action seems socially just,
problems can result when the high costs of business
Fiscal Policy
579
Figure 18.1 How has the national minimum wage changed over time?
The national minimum wage has increased from 40 cents an hour in 1947 to $7.25 in 2010. When inflation is considered,
however, workers earned their highest minimum wages in the 1960s and 1970s.
Source: Economic Policy Institute, “Minimum Wage Issue Guide,” www.epi.org/publications/entry/issue_guide_on_minimum_wage/.
10
8
6.96
7
7.74 7.94
7.29
7.69
6.48
4.75
3
3.80
2
1
6.01
5.85
4.25
3.40
7.25
5.15
6.00
5
4
6.61
6.42
5.90
6
Dollars
Constant (1996) dollars
Current dollars
8.71
9
.40
.75
1.00
1.15 1.25
1.40
1.60
2.00
2010
2007
1997
1987
1977
1967
1957
1947
0
Year
make it difficult for corporations to operate, particularly when wages are much lower
abroad and there are few barriers to international trade (see chapter 19).
INCREASING INTERDEPENDENCE
The increased interdependence of economies
in an age of globalization suggests that U.S. economic fortunes are more intensively
tied to global economic factors. One way to measure this increasing interdependence
is to examine regional shares of the world gross domestic product (GDP), or the
total market value of all goods and services produced in an area during a year. In 2009,
the United States, the European Union, and Asia each represented between 25 and
30 percent of the world’s GDP. Latin America and the Middle East each held another
gross domestic product (GDP)
The total market value of all goods
and services produced in an area
during a year.
How has economic interdependence altered the American economy? The cheap cost of labor
Photo courtesy: EPA/RAHAT DAR/Landov
abroad has led many Americans to lose their jobs, particularly at manufacturing plants. Here,
workers at a factory in Pakistan assemble soccer balls.
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Economic Policy
5 to 7 percent of the world’s GDP. This distribution represents much greater international equality than in other eras.10
This greater equity is at least in part attributable to emerging economies like
China, India, and Brazil, which are continuing to post robust growth rates, driven by
strong domestic demand and fiscal solvency. Oil-rich countries are also posting large
surpluses. The United States, on the other hand, has been running persistent deficits.
Foreigners held almost $4 trillion in U.S. securities in 2010. (To learn more about who
holds U.S. debt, see Figure 18.2.)
The growing influence of sovereign wealth funds—the investment arms of states
with huge surpluses—on the U.S. economy is obvious and worrying for those concerned with relative loss of economic dominance and sovereignty. The alarming 2008
economic crisis that began in the U.S. credit markets and spread swiftly throughout
the globe raised a different perspective on the greater economic interdependence that
has resulted from globalization: when a large economy like that of the United States
suffers a major shock, the fallout will have a severe impact on the global economy.
The Budget
The primary purpose of the national budget is to fund government programs. But,
manipulating the budget can also be used as a fiscal policy tool to stabilize the economy and to counteract fluctuations. National budget planning is complex and disjointed, and it begins roughly a year and a half before the beginning of the fiscal year
in which it takes effect. The fiscal year begins on October 1 of one calendar year and
runs through September 30 of the following calendar year. The fiscal year takes its
name from the calendar year in which it ends; thus the time period from October 1,
2011, through September 30, 2012, is designated fiscal year (FY) 2012.
Figure 18.2 Who holds U.S. debt?
China holds the greatest percentage of American debt, but Japan and Great Britain also hold large amounts of U.S. Treasury securities.
Source: “A Tsunami of Red Ink,” Chicago Tribune (May 24, 2010): www.chicagotribune.com/news/sc-nw-0425-debt.eps-20100424,0,956270.graphic.
CANADA
$67.1
billion
GREAT BRITAIN
$321.7 billion
LUXEMBOURG
$77.9 billion
SWITZERLAND
$81.8 billion
RUSSIA
$120.2 billion
CHINA
$877.5 billion
OIL EXPORTERS
$218.8 billion
CARIBBEAN
BANKING CENTERS
$144.5 billion
BRAZIL
$170.8
billion
HONG KONG
$152.4 billion
JAPAN
$768.5 billion
TAIWAN
$121.4 billion
Fiscal Policy
The Living Constitution
A
The Congress shall have power to lay and collect taxes on
incomes, from whatever source derived, without apportionment
among the several States, and without regard to any census or
enumeration.
s the national government’s role in economic
regulation grew larger in the late eighteenth
century, its administrative costs began to grow. Congress sought to rectify this situation by enacting a
law that levied a national income tax. However, in
Pollock v. Farmers’ Loan & Trust Co. (1895), a divided
Supreme Court held that levying such a tax by
statute was unconstitutional.
Ratified on February 3, 1913, the Sixteenth
Amendment addressed this shortcoming by modifying the Article I prohibition against levying a “direct
tax” on individual property.The first income tax was
levied concurrently with the adoption of the amendment. At that time, all Americans were required to give
2 percent of their income to the national government.
Although the U.S. government continues to
levy an income tax today, much about the tax rate
has changed. Today, national income taxes are progressive, meaning that the tax rate that citizens
must pay increases with income. In 2010, the tax
rate for a single American making less than $8,375
was 10 percent. In contrast, those who made more
than $373,651 were required to pay 33 percent of
their income in taxes.
The national income tax continues to be one
of the most controversial federal policies. Few
—SIXTEENTH AMENDMENT
Americans truly enjoy paying taxes, and many citizens find the tax code to be complicated and full of
loopholes. Reformers across the political spectrum
have suggested ways to alter the tax code to make it
fairer, or to assure that it does not place too great of
a burden on low-income Americans. One of the
most popular of these proposals is a flat tax, which
is used in several American states. Under such a
system, all citizens, regardless of income, pay the
same tax rate. In Pennsylvania, for example, all residents pay 3 percent of their income to the state
government.
CRITICAL THINKING QUESTIONS
1. How has the creation of a national income tax
helped to expand the powers of the national
government?
2. What types of proposals to reform the
U.S. tax code seem fairest to all citizens?
Simplest? Most sufficient for raising
necessary revenues?
3. Should Congress and the president be able to
make changes to the tax code by statute, or
should such modifications require a
constitutional amendment?
RAISING AND SPENDING MONEY The national government raises money from
a variety of sources, with individual income taxes and social insurance and retirement
receipts representing the largest portions of the funds received. Social insurance and
retirement receipts include Social Security, hospital insurance, and other taxes; they
account for 40.5 percent of total receipts. Income taxes account for the remaining 43.2
percent of total federal government income.11 (To learn more about the government’s
ability to raise revenue, see The Living Constitution: The Sixteenth Amendment.)
Most government spending is directed toward national defense and human
resources. Defense spending consists primarily of maintaining the U.S. armed forces
and developing the weapons the military needs; it accounts for 18.8 percent of the
budget. Human resources include the spending categories of health, income security,
and Social Security. In 2009, the human resources share of total outlays was 61.6 percent.
(To learn more about federal receipts and outlays, see Figure 18.3.)
581
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CHAPTER 18
Economic Policy
Figure 18.3 How does the federal government raise and spend money?
Source: United States Budget, Fiscal Year 2011, www.gpoaccess.gov.
Where It Comes From
Other 5.7%
Excise Taxes 3.4%
Net Interest 5.3%
Physical
Resources
12.4%
Corporate
Income
Taxes
7.2%
Social
Insurance and
Retirement
Receipts
40.5%
Where It Goes*
Individual
Income Taxes
43.2%
National
Defense
18.8%
Other Functions
4.6%
Human
Resources
61.6%
*2.6% Undistributed offsetting receipts
THE CONGRESSIONAL BUDGET PROCESS The Budget and Accounting Act of
1921 gave the president authority to prepare an annual budget and submit it to
Congress for approval. The act also created a staff agency now called the Office of
Management and Budget (OMB) to assist the president and handle the details of
budget preparation. Although the president sends a budget proposal to Congress in
January or February of each year, work on the budget within the executive branch
begins nine or ten months earlier. (To learn more, see Table 18.1.) Acting in accordance
with presidential decisions on the general structure of the budget, the OMB provides
the various departments and agencies with instructions and guidance on presidential
priorities to help them in preparing their budget requests. The departments and agencies then proceed to develop their detailed funding requests. The OMB reconciles the
discrepancies between presidential and agency preferences, but it should be remembered that the OMB’s mission is to defend the presidential budgetary agenda.12
To give itself more control over the budget process, Congress enacted the Congressional Budget Act of 1974. The act established a budget process that includes setting
Table 18.1 How is the federal budget made?
First Monday in February
February 15
Congress receives the president’s budget.
February 25
Congressional committees submit views and estimates on spending to the
budget committees.
April 1
Budget committees report concurrent resolution on the budget, which sets
a total for budget outlays, an estimate of expenditures for major budget
categories, and the recommended level of revenues. This resolution acts
as an agenda for the remainder of the budget process.
April 15
Congress completes action on concurrent resolution on the budget.
May 15
Annual appropriations bills may be considered in the House.
June 10
House Appropriations Committee completes action on regular
appropriations bills.
June 15
Congress completes action on reconciliation legislation, bringing budget
totals into conformity with established ceilings.
June 30
House completes action on all appropriations bills.
October 1
The new fiscal year begins.
Congressional Budget Office (CBO) reports to the budget committees on fiscal
policy and budget priorities, including an analysis of the president’s budget.
Source: Adapted from Howard E. Shuman, Politics and the Budget, 3rd ed. © 1992. Reprinted by permission of Prentice Hall, Inc., Upper
Saddle River, NJ.
Monetary Policy
583
overall levels of revenues and expenditures, the size of the budget surplus or deficit, and
priorities among different “functional” areas (for example, national defense, transportation, agriculture, foreign aid, and health). It also empowered the House and Senate to
establish budget committees to perform these tasks and authorized the Congressional
Budget Office (CBO), a professional staff of technical experts, to assist the budget committees and to provide members of Congress with their own source of budgetary information so they would be more independent of the OMB.
Typically, budget committees hold hearings on the president’s proposed budget
and set targets for overall revenue and spending and a ceiling for individual categories
of spending. Other committees evaluate requests by various agencies. In most years,
reconciliation legislation is necessary to ensure that targets are met. Changes in existing tax rates or benefit levels can be proposed in reconciliation bills. The reconciliation procedure also relaxes some of the Senate rules, including the filibuster. It was
used in 2010 to enact the health insurance reform bill.
Legislative action on all appropriations bills is supposed to be completed by October
1, the start of the fiscal year. It is rare, however, for Congress to pass all appropriations bills
by this date. For programs still unfunded at the start of the fiscal year, Congress can pass a
continuing resolution, which authorizes agencies to continue operating on the basis of last
year’s appropriation until approval of their new budget. This procedure can cause some
uncertainty in agency operations. When the president and Congress cannot agree, some
programs may be shut down until the terms for a continuing resolution are worked out.
DEFICITS AND DEBT
Most states are required by constitution or by statute to have
a balanced budget—revenues must meet or exceed expenditures—but this is not the
norm for the federal government. The federal government rarely spends exactly as
much as it raises. Instead, it usually has a budget surplus or deficit. In years when the
federal government is under budget, it is said to have a budget surplus—this means
that revenues have exceeded expenditures and the government has money left over.
Although the government had surpluses from 1998 to 2001, it is much more common for the federal government to have a budget deficit, the economic condition that
occurs when expenditures exceed revenues. This is the functional equivalent of the government being “in the red.” It may be the result of deficit spending to stimulate the
economy, funding of costly policies such as wars or social welfare programs, tax cuts that
decrease the amount of money the government receives, or some combination of all of
these factors. In recent years, for example, the government has run high deficits as a
result of Bush administration tax cuts, the wars in Iraq and Afghanistan, and spending
on the bailout and recovery bills. In fiscal year 2010, for example, the federal government
was projected to have a budget deficit of $10.6 billion.13 Although this figure is high in
absolute terms, as a percentage of GDP, it remains smaller than the deficits of the 1960s.
In the short term, budget deficits may have positive economic benefits. However,
in the long term, running deficits year after year can have negative consequences. The
sum of annual budget deficits is known as the national debt; in 2010, this total
exceeded $13 trillion. A high national debt such as this can stifle economic growth
and cause inflation, a rise in the general price levels of an economy. The national
debt—like personal debt in the form of credit cards and student loans—must also be
paid back with interest. This can be a costly proposition that diverts attention and
money from other governmental programs for years to come.
budget deficit
The economic condition that occurs
when expenditures exceed revenues.
inflation
A rise in the general price levels of
an economy.
Monetary Policy
18.3 . . . Analyze the effect of the Federal Reserve System on monetary policy.
The government conducts monetary policy by managing the nation’s money supply and
influencing interest rates. The Federal Reserve System (informally, “the Fed”), especially
its Board of Governors, handles much of the day-to-day management of monetary
monetary policy
A form of government regulation in
which the nation’s money supply and
interest rates are controlled.
584
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Economic Policy
policy. The Fed is given a number of tools to aid its efforts, including the ability to set
reserve requirements, control the discount rate, and open market operations.
The Federal Reserve System
Board of Governors
In the Federal Reserve System, a
seven-member board that makes
most economic decisions regarding
interest rates and the supply of
money.
Created in 1913 to adjust the money supply to the needs of agriculture, commerce,
and industry, the Federal Reserve System comprises the Federal Reserve Board, the
Federal Open Market Committee (FOMC), the twelve Federal Reserve Banks in
regions throughout the country, and other member banks.14 Typically, the Board of
Governors of the Federal Reserve System, a seven-member board that makes most
economic decisions regarding interest rates and the supply of money, dominates this
process. (To learn more about the organization of the Federal Reserve System, see
Figure 18.4.)
The president appoints (subject to Senate confirmation) the seven members of
the Board of Governors, who serve fourteen-year, overlapping terms. The president
can remove a member for stated causes, but this has never occurred. The president
designates one board member to serve as chair for a four-year term, which runs from
the midpoint of one presidential term to the midpoint of the next to ensure economic stability during a change of administrations. It also prevents monetary policy
from being influenced by political considerations. The current chair, Ben Bernanke,
has served since 2006 and was initially appointed by President George W. Bush. He
was reappointed by President Barack Obama for a second term beginning in 2010.
Figure 18.4 How does the Federal Reserve System work?
Source: Board of Governors of the Federal Reserve System.
BOARD OF GOVERNORS
7 members appointed
by the president
of the United States
and confirmed by
the Senate
FEDERAL OPEN MARKET
COMMITTEE
7 members of the
Board of Governors
5 of the 12 Federal
Reserve Bank presidents
FEDERAL RESERVE
BANKS
MEMBER BANKS
12 banks operating
25 branches, and
9 additional offices for
processing checks
3400 banks
Each bank with 9
directors
3 Class A banking
3 Class B public
APPOINTS
ADDRESS
Federal Advisory Council
(12 members)
1 from each district
3 Class C public
Directors at each
Federal Reserve Bank
appoint
APPOINT
President
APPROVES
APPOINTMENTS
AND SALARIES
APPROVES SALARIES
CONTRIBUTE CAPITAL
First vice president
Officers and employees
Size groupings
ELECT
Large
Medium
Small
Each size group selects
one Class A and one
Class B director in each
Federal Reserve District
Monetary Policy
585
Bernanke: A “Big Picture” Reform
Approach Needed
By Jeannine Aversa
The Federal Reserve is working to beef up oversight of financial companies to better
protect the nation from another financial crisis in the future, Chairman Ben Bernanke said
Wednesday.
The Fed chairman’s comments come as Congress moves closer to sending President
Obama a final legislative package that revamps the nation’s financial structure to prevent a
replay of the recent financial crisis.
Bernanke welcomed key parts of that package in remarks prepared for delivery to a
conference in New York. At the same time, though, Bernanke emphasized that the Fed is
moving ahead on its own reforms.
For instance, the Fed is working to strengthen capital requirements for banks so that
they’ll have bigger and better cushions to protect against any potential losses. And, the Fed
is collecting more information on linkages among financial companies to better identify
potential channels of financial contagion.
One of the lessons learned from the crisis is that the Fed can’t focus solely on the
safety and soundness of individual banks, but rather on the health of the financial system
as a whole, Bernanke said. The Fed has already moved to examinations that take this
broader-picture approach.
“Regulatory agencies must thus supervise financial institutions and critical
infrastructures with an eye toward overall financial stability as well as the safety and
soundness of each individual institution and system,” Bernanke said. . . .
Bernanke embraced provisions contained in both the Senate- and House-passed
financial overhaul measures that would create a council of regulators—which includes the
Fed—to police for risky practices that could endanger the financial system. Concentrating
all such powers within a single agency, he said, could create “regulatory blind spots.” . . .
Bernanke also welcomed provisions in the House and Senate bills that would allow for
the safe dismantling of a big financial firm, whose failure could put the economy in jeopardy.
The mechanism is similar to how the Federal Deposit Insurance Corp. shutters failing banks.
Prior to this appointment, he served
as chair of President George W.
Bush’s Council of Economic Advisors. (To learn more about recent
reforms to the Federal Reserve Board,
see Politics Now: Bernanke: A “Big
Picture” Reform Approach Needed.)
The primary monetary policy tools are
the setting of reserve requirements for
member banks, control of the discount
rate, and open market operations.
Critical Thinking Questions
1. How do these reforms
expand and contract
the power of the
Federal Reserve Board?
2. Should the government
have the power to
dismantle failing
financial firms? Why or
why not?
3. What additional
changes need to be
made to the
government’s
involvement in the
economy in order to
forestall another
financial crisis?
Who is the chair of the Federal Reserve Board? Fed Chairman Ben Bernanke served as chair
of the Council of Economic Advisors before assuming his current role.
Photo courtesy: AP/Wide World Photos
The Tools of Monetary
Policy
June 17, 2010
The Associated Press
www.pressherald.com
586
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Economic Policy
Economic Freedom
One way to evaluate how hospitable a country is to business is by
looking at the rankings of countries on the Economic Freedom of
the World Index prepared by the Economic Freedom Network
(www.freetheworld.com). The index weights 42 different factors
to assign each country an economic freedom score on a ten-point
scale. As the table reveals, Hong Kong has the highest rating for
economic freedom, followed by Singapore. Nations with the lowest economic freedom scores include Myanmar and Zimbabwe.
Ranking
1
2
6
19
39
50
57
68
82
100
120
140
141
Country
Score
Hong Kong
Singapore
United States
United Arab Emirates
Spain
Botswana/Kazakhstan
South Africa
Mexico
China
Dominican Republic
Ecuador
Myanmar
Zimbabwe
8.97
8.66
8.06
7.58
7.32
7.12
7.06
6.85
6.54
6.27
5.83
3.69
2.89
Source: Economic Freedom Network, “Economic Freedom of the World: 2009 Annual Report,”
www.freetheworld.com/2009/reports/world/EFW2009_ch1.pdf.
■
What factors should be used to define economic freedom
around the world?
■
What about these rankings is most and least surprising to
you? How might you explain these findings?
■
China has one of the top five gross domestic products in the
world, yet it ranks 82nd in terms of economic freedom—its
index score is 6.54. How is it possible to have a large economy
while simultaneously lacking a high level of economic freedom?
Reserve requirements set by the Federal Reserve designate the portion of deposits that member banks must
retain as backing for their loans. The reserves determine
how much or how little banks can lend to businesses
and consumers. For example, if the FRB changed the
reserve requirements and allowed banks to keep $10 on
hand rather than $15 for every $100 in deposits that it
held, it would free up additional money for loans.
The discount rate is the rate of interest at which
the Federal Reserve Board lends money to member
banks. Lowering the discount rate encourages member
banks to increase their borrowing from the Fed and
extend more loans at lower rates. This expands economic activity, since when rates are lower, more people
should be able to qualify for car loans or mortgages. As
a consequence of cheaper interest rates, more large
durable goods (such as houses and cars) should be produced and sold.
Open market operations are the buying and
selling of government securities by the Federal
Reserve Bank. The Federal Open Market Committee
meets periodically to decide on purchases or sale of
government securities to member banks. When
member banks buy long-term government bonds,
they make dollar payments to the Fed and reduce the
amount of money available for loans. Fed purchases
of securities from member banks in essence give the
banks an added supply of money. This action
increases the availability of loans and should decrease
interest rates. Decreases in interest rates stimulate
economic activity.
In addition to these formal tools, the FRB can also
use “moral suasion” to influence the actions of banks
and other members of the financial community by suggestion, exhortation, and informal agreement. Because
of its commanding position as a monetary policy
maker, the media, economists, and market observers
pay attention to verbal signals about economic trends
and conditions emitted by the FRB and its chair.
Income Security Policy
reserve requirements
Government requirements that a
portion of member banks’ deposits be
retained as backing for their loans.
discount rate
The rate of interest at which the
Federal Reserve Board lends money
to member banks.
open market operations
The buying and selling of
government securities by the Federal
Reserve Bank.
18.4 . . . Describe the evolution of income security policy in the United States.
Income security programs protect people against loss of income because of retirement, disability, unemployment, or death or absence of the family breadwinner. These
programs, like many of the other issues we have discussed in this chapter, were not a
priority for the federal government during much of its first 150 years. However,
beginning with the passage of the Social Security Act as a part of the 1930s New
Deal, the government began to pay greater attention to this policy area. Today, the
federal government administers a range of income security programs. These policies
fall into two major areas—non-means-tested programs (in which benefits are provided regardless of income) and means-tested programs (in which benefits are
provided to those whose incomes fall below a designated level).
Income Security Policy
Photo courtesy: Reuters/Landov
Who is responsible for setting interest rates? The Federal Open Market Committee, shown here,
establishes interest rates on lending and borrowing.
The Foundations of Income Security Policy
With the election of President Franklin D. Roosevelt in 1932, the federal government
began to play a more active role in addressing hardships and turmoil that grew out of
the Great Depression. An immediate challenge facing the Roosevelt administration
was massive unemployment, which was viewed as having a corrosive effect on the economic well-being and moral character of American citizens. In Roosevelt’s words, an
array of programs to put people back to work would “eliminate the threat that
enforced idleness brings to spiritual and moral stability.”15
To address the issue of unemployment, Roosevelt issued an executive order in
November 1933 that created the Civil Works Administration (CWA). The intent of
the CWA was to put people to work as quickly as possible for the stated goal of building public works projects. Within a month of its start, CWA had hired 2.6 million
people; at its peak in January 1934, it employed more than 4 million workers. But,
critics quickly claimed that it was too political and rife with corruption. The CWA
was disbanded in 1934.
In 1935, the notion of a federal work program was revived in the form of the
Works Progress Administration (WPA). The WPA paid a wage of about $55 a
month, which was sizeable for the time, but below what would be available in the private sector. Such a wage was designed to reward work, but not discourage individuals
from seeking market-based employment. A number of concrete accomplishments
were attained through the WPA. About 30 percent of the unemployed were absorbed;
the WPA also constructed or improved more than 20,000 playgrounds, schools, hospitals, and airfields.16 These jobs programs established the notion that, in extreme circumstances, the government might become the employer of last resort.
A more permanent legacy of the New Deal was the creation of the Social Security program. The intent of Social Security was to go beyond the various “emergency”
587
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Economic Policy
Social Security Act
A 1935 law that established old age
insurance; assistance for the needy,
aged, blind, and families with
dependent children; and unemployment insurance.
programs such as the WPA and provide at least a minimum of economic security for
all Americans. Passage of the Social Security Act in 1935, thus represented the beginning of a permanent welfare state in America and a dedication to the ideal of greater
equity. The act consisted of three major components: (1) old-age insurance (what we
now call Social Security); (2) public assistance for the needy, aged, blind, and families
with dependent children (known as SSI); and, (3) unemployment insurance and compensation. Since that time, the program has been expanded to include a much greater
percentage of American workers. It has also become one of the most successful government programs. In the 1930s, poverty rates were highest among the elderly. Today,
seniors have the lowest rate of poverty among any age group in the United States.
Income Security Programs Today
entitlement programs
Government benefits that all
citizens meeting eligibility criteria—
such as age, income level, or unemployment—are legally “entitled” to
receive.
non-means-tested programs
Programs that provide cash
assistance to qualified beneficiaries,
regardless of income. Among these
are Social Security and
unemployment insurance.
means-tested programs
Programs that require that beneficiaries have incomes below specified
levels to be eligible for benefits.
Among these are SSI, TANF, and
SNAP.
Modern income security programs help a wide variety of citizens to survive in cases of
unintentional loss of income. They also help disabled, elderly, and low-income citizens
to make ends meet and provide a minimally decent standard of living for themselves
and their families. In 2009, the poverty threshold for a four-person family unit was
$22,050. (To learn more about the number of Americans who benefit from income
security programs, see Table 18.2.)
Many income security programs are entitlement programs, government
benefits that all citizens meeting eligibility criteria—such as age, income level, or
unemployment—are legally “entitled” to receive. Unlike programs such as public
housing, military construction, and space exploration, spending for entitlement
programs is mandatory and places a substantial ongoing financial burden on the
national and state governments.
Income security programs fall into two general categories. Many social insurance
programs are non-means-tested programs that provide cash assistance to qualified
beneficiaries, regardless of income. These social insurance programs operate in a manner
somewhat similar to private automobile or life insurance. Contributions are made by
or on behalf of the prospective beneficiaries, their employers, or both. When a person
becomes eligible for benefits, they are paid as a matter of right, regardless of the person’s wealth or unearned income. Among these programs are old age, survivors, and
disability insurance (Social Security) and unemployment insurance.
In contrast, means-tested programs require that people must have incomes
below specified levels to be eligible for benefits. Benefits of means-tested programs may come either as cash or in-kind benefits, such as help with finding
employment or child care. Included in the means-tested category are the Supplemental Security Income (SSI) program, Temporary Assistance for Needy Families
(TANF), and the Supplemental Nutrition Assistance Program (SNAP, also known
as food stamps).
Table 18.2 How many Americans benefit from income security programs?
Program
Population
Non-Means-Tested
Social Security (OASDI)
Unemployment Insurance
Means-Tested
Supplemental Security Income
Temporary Assistance for Needy Families
Supplemental Nutrition Assistance Program
Number of
Recipients (Millions)
Percentage of
U.S. Population
50.5
4.6
16.3
1.5
7.7
3.8
39.7
2.5
1.2
12.8
Sources: Social Security Administration, www.ssa.gov; Department of Health and Human Services, acf.dhhs.gov; Food Research Action
Center, www.frac.org; Veterans’ Affairs, Bureau of Labor Statistics, www.bls.gov/cps.
Income Security Policy
OLD AGE, SURVIVORS, AND DISABILITY INSURANCE As men-
Should Social Security be privatized? Social Security privatization has been a hotbutton issue. Here, members of Congress speak at a rally opposing privatization.
Photo courtesy: MICHAEL KLEINFELD/UPI/Landov
tioned earlier, the Social Security
program is a non-means-tested program that began as old-age insurance,
providing benefits only to retired
workers. Its coverage was extended to
survivors of covered workers in 1939
and to the permanently disabled in
1956. Nearly all employees and most
of the self-employed are now covered
by Social Security. Americans born
before 1938 are eligible to receive full
retirement benefits at age sixty-five.
The full retirement age gradually rises
until it reaches sixty-seven for persons born in 1960 or later. In early
2010, the average monthly Social
Security benefit for retired workers
was $1,164 with the maximum
monthly benefit set at $2,346.
Social Security is not, as many people believe, a pension program that collects
contributions from workers, invests them, and then returns them with interest to beneficiaries. Instead, current workers pay employment taxes that go directly toward providing benefits for retirees. In 2010, for example, a tax of 7.65 percent was levied on
the first $106,800 of an employee’s wages and placed into the Social Security Trust
Fund. An equal tax was levied on employers.
As a result of this system, in recent years, it has become increasingly apparent that
the current Social Security system is on a collision course with itself. Americans are living longer and having fewer children. And, beginning in 2010, the Baby Boom generation (roughly speaking, those born in the two decades immediately following World
War II) begins to retire. These factors, taken together, skew the number of working
Americans per retiree, and lead the Social Security system toward financial insolvency.
The trustees of the Social Security Trust Fund have estimated that—barring major policy changes—by 2017, payments to beneficiaries will exceed revenues collected from
employees.
A number of proposals have been made to address these shortcomings. Among
them are raising the age of eligibility for beneficiaries or increasing the Social Security
tax withheld from employees. Both of these proposals have received criticism from
citizens—seniors and those who are soon to retire do not want to see their benefits
cut or limited, and workers do not want to pay additional taxes.
One reform proposal that received a great deal of attention in the 2000 presidential election and the years that followed was Social Security privatization. Essentially,
this would amount to the federal government allowing citizens to work with private
industry to administer and invest the monies in the Social Security Trust Fund. Some
Americans believe that such a system would increase the government’s return on
investment and prolong the life of the existing Social Security system with few other
changes. Others believe that a privatized Social Security system is risky and will leave
behind those who it is intended to aid the most.
UNEMPLOYMENT INSURANCE Unemployment insurance is a non-means-tested
program financed by a payroll tax paid by employers. The program benefits full-time
employees of companies of four or more people who become unemployed through no
fault of their own. Benefits are not paid to unemployed workers who have been fired
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Economic Policy
Figure 18.5 How do state unemployment rates vary?
In May 2010, the national unemployment rate was 9.7 percent. However, this rate varied
tremendously across the country, with the highest levels in the South and West, and the
lowest levels in the Midwest.
Source: United States Department of Labor, www.dol.gov.
WA
MT
OR
WY
CA
WI
SD
ME
UT
CO
IL
KS
OK
NM
WV
MO
VA
KY
AR
SC
AL
NJ
DE
RI
CT
MD
DC
NC
TN
MS
TX
PA
OH
IN
MA
NY
MI
LA
NE
AZ
GA
LA
FL
AK
NH
MN
ID
NV
VT
ND
10.0% or over
7.0% to 9.9%
6.0% to 6.9%
5.0% to 5.9%
4.0% to 4.9%
3.0% to 3.9%
2.0% to 2.9%
1.9% or below
HI
for personal faults or who quit their jobs, or those who are unwilling to accept suitable
employment.
State governments administer unemployment insurance programs. As a result,
unemployment programs differ considerably in levels of benefits, length of benefit
payment, and eligibility for benefits. For example, in 2009, average weekly benefit
payments ranged from less than $200 in Mississippi to almost $500 in Hawaii and
Massachusetts. In general, less generous programs exist in southern states, where labor
unions are less powerful. Nationwide, only about half of the people who are counted
as unemployed at any given time are receiving benefits.
In May 2010, the national unemployment rate stood at 9.7 percent. But, there
were considerable differences across the country. In the Dakotas and Nebraska,
unemployment rates were slightly less than 5 percent, while levels of unemployment
in many southern and western states such as Florida and California were over 10
percent. Unemployment rates also varied considerably across races and by age. For
example, levels of unemployment for African American males were nearly twice that
of whites, with unemployment rates exceeding 40 percent or greater common
among young African American males. (To learn more about variations in unemployment rates, see Figure 18.5.)
Income Security Policy
SUPPLEMENTAL SECURITY INCOME
The Supplemental Security Income
(SSI) program is a means-tested program that began under the Social Security Act as
a government benefit for needy elderly or blind citizens. In 1950, Congress extended
coverage to needy people who were permanently and totally disabled. Primary funding for SSI is provided by the national government, which prescribes minimum
national benefit levels. The states may also choose to supplement national benefits,
and forty-eight states take advantage of this option.
To be eligible for SSI, beneficiaries can only have limited income; the lower
an individual’s income, the higher their SSI payment. SSI beneficiaries may
also only have a limited amount of possessions. The total of an individual’s personal resources, including bank accounts, vehicles, and personal property cannot
exceed $2,000. In 2010, monthly payments to eligible beneficiaries were about
$500 per person.
FAMILY AND CHILD SUPPORT The Aid to Dependent Children program is a
means-tested program that was first established as part of the Social Security Act
in 1935. In 1950, it was broadened to include not only dependent children without
fathers but also mothers or other adults with whom dependent children were living. At this time, it was retitled the Aid to Families and Dependent Children
(AFDC) program. As a result of this change and changes in the American family
(including a rise in the birthrate to unwed mothers and a rise in the divorce rate),
the family and child support rolls expanded significantly in the latter part of the
twentieth century.
By the 1990s, the growth of this program began to attract widespread criticism
from many conservatives and moderates, including Democratic President Bill Clinton. Critics pointed to the rising number of recipients and claimed that the AFDC
program encouraged promiscuity, out-of-wedlock births, and dependency that
resulted in a permanent class of welfare families. To restrict the availability of aid, to
ferret out fraud and abuse, and to hold down cost, public officials sought to reform
the program.
In what was hailed as the biggest shift in income security policy since the
Great Depression, a new family and child support bill, the Personal Responsibility
and Work Opportunity Reconciliation Act (PRWORA) of 1996, created the
Temporary Assistance for Needy Families (TANF) program to replace AFDC.
The most fundamental change enacted in the new law was the switch in funding
welfare from an open-ended matching program to a block grant to the states.
PRWORA also gave states more flexibility in reforming their welfare programs
toward work-oriented goals.
Significant features of the TANF plan included (1) a requirement that single
mothers with a child over five years of age must find work within two years of
receiving benefits; (2) a provision requiring that unmarried mothers under the age
of eighteen live with an adult and attend school in order to receive welfare benefits;
(3) a five-year lifetime limit for aid from block grants; (4) a requirement that mothers must provide information about a child’s father in order to receive full welfare
payments; (5) cutting off food stamps and Supplemental Security Income for legal
immigrants; (6) cutting off cash benefits and food stamps for convicted drug felons;
and, (7) limiting food stamps to three months in a three-year period for persons
eighteen to fifty years old who are not raising children and not working.17
The success of the TANF program has been widely debated. The total number of
Americans receiving benefits has fallen. But, there is little evidence that the program
has been successful at job training or as a means of reducing economic and social
inequality. Despite these potential shortcomings, the act was reauthorized several
591
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Economic Policy
times during the Bush administration. In 2010, it became the subject of significant
political wrangling, and the scope of the program was cut, at least temporarily.
EARNED INCOME TAX CREDIT The Earned Income Tax Credit (EITC) is a
means-tested program created in 1975 at the insistence of Senator Russell Long
(D–LA). The intent of the EITC was to enhance the value of working and encourage families to move from welfare to work. Advocates also claimed that the program would enhance spending, which would in turn stimulate the economy. In
addition to this stimulus, supporters of the EITC had two other objectives: (1) to
increase work incentives among the welfare population; and, (2) to refund indirectly part or all of the Social Security taxes paid by workers with low incomes.18
To claim the EITC on tax returns, a person must have earned income during the
year. During 2009, an individual’s earned income had to be less than $13,440 if there
were no qualifying children, $35,463 with one qualifying child, and $43,279 with
ANALYZING VISUALS
The Supplemental Nutrition
Assistance Program
The Supplemental Nutrition Assistance Program (SNAP), more popularly known as the food stamp program, provides
benefits to almost 40 million Americans. The average recipient receives $133.13 a month to aid in the purchase of
groceries. Citizens may spend these funds at their discretion, subject to minor limitations. Review the purchasing
guidelines for SNAP recipients in the state of Alaska (which are typical of most state food stamp programs), and
answer the questions.
Food Items that May Be Purchased
with Food Stamp Benefits
■ Food or food products fit for human consumption
■ Vegetable and herb seeds
■ ”Health foods” such as wheat germ, brewer’s yeast,
and edible seeds
■ Baby formula, diabetic, and diet foods
■ Items used for food preparation and preservation,
such as pectin and shortening
■ Snack foods such as candy, chips, gum, and sodas
■ Distilled water and ice, if labeled “For Human
Consumption”
■ Meals prepared for the elderly or disabled by
authorized agencies
Food Items that May Not Be Purchased
with Food Stamp Benefits
■ Items not meant to be eaten by people, such as laundry
starch, pet foods, and decorative dyes
■ Items used for gardening, such as fertilizer and peat moss
■ Health aids such as aspirin and antacids
■ Therapeutic items such as vitamins and minerals
■ Items for food preparation and preservation such as
pressure cookers and canning jars
■ Alcoholic beverages and tobacco
■ Nonfoods such as soap, toiletries, paper products, and
utensils
■ Prepared hot foods sold in the store and ready to be
eaten immediately
Source: Alaska Department of Health and Social Services, www.hss.state.ak.us/dpa/programs/fstamps/howto.html.
■
■
■
What differences exist between items that can and cannot be purchased with food stamps?
If you were on food stamps, what items might you buy to maximize your budget? What items that you buy today
might you not be able to purchase?
Would your choices have any nutritional consequences?
Toward Reform: Recession and Economic Recovery
593
three or more qualifying children. In recent years, about 23 million families filing federal income tax returns (roughly one tax return in six) claimed the EITC. The success
of the national EITC in reducing poverty has led twenty-four states to enact similar
state tax credits.19
SUPPLEMENTAL NUTRITION ASSISTANCE PROGRAM The first attempt at this
means-tested program (1939–1943), which is more commonly known as food stamps,
was primarily an effort to expand domestic markets for farm commodities. Food
stamps provided the poor with the ability to purchase more food, thus increasing the
demand for American agricultural produce. Attempts to reestablish the program during the Eisenhower administration failed, but in 1961, a $381,000 pilot program
began under the Kennedy administration. It was made permanent in 1964 and
extended nationwide in 1974.
The method of delivering the food stamp benefit has changed dramatically
over time. For much of the program’s history, the benefit was administered as
actual paper coupons—quite literally, food “stamps”—given to citizens who were
eligible for relief. Today, the program is administered entirely using an electronic
debt program, much like an ATM card. This change in administration necessitated
a formal name change for the program—from food stamps to the Supplemental
Nutrition Assistance Program—in 2008. Still, this benefit continues to be an
important means of assuring income security. In 2009, more than 40 million Americans received SNAP aid. The average participant received $133 worth of assistance
per month. (To learn more about SNAP, see Analyzing Visuals: The Supplemental
Nutritional Assistance Program.)
In addition to SNAP, the national government operates several other food programs for the needy. These programs include a special nutritional program for women,
infants, and children known as WIC; a school breakfast and lunch program; and an
emergency food assistance program.
TOWARD REFORM: Recession and
Economic Recovery
18.5 . . . Evaluate the role of fiscal, monetary, and income security policy
in the economic recession and recovery.
As discussed in the opening vignette, by 2008, it became increasingly clear that the
extended period of American economic stability—a situation in which there is economic growth, rising national income, high employment, and steadiness in the general level of prices—was quickly coming to an end. Rising unemployment and
government expenditures, coupled with a collapsing mortgage industry, created a
severe economic downturn. By the end of 2008, this downturn had become a fullblown recession, a decline in the economy that occurs as investment sags, production
falls off, and unemployment increases.
The national government identified this crisis situation quickly and took a number of actions using fiscal, monetary, and income security policies to attempt to restart
economic stability
A situation in which there is
economic growth, rising national
income, high employment, and steadiness in the general level of prices.
recession
A decline in the economy that
occurs as investment sags,
production falls off, and unemployment increases.
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CHAPTER 18
Economic Policy
economic growth and stimulate the economy. We consider the ways the government
used each of these policies in turn.
Fiscal Policy
Photo courtesy: AP/Wide World Photos
At the first signs of an economic slowdown in early 2008, the national government
acted quickly to stimulate the economy and attempt to reinvigorate consumer
spending through the use of fiscal policy. The first of these government actions was
to fund a $168 billion stimulus package that included individual tax rebates for
most people who had paid taxes for tax year 2007. These payments were designed
to encourage lower- and middle-income people to spend money. Most citizens who
received a check got $600 if they filed individually, or $1,200 if they filed jointly.
There were increasing incentives for dependent children, and decreasing incentives
for wealthy Americans. (To learn more about these stimulus payments, see Join the
Debate: Do Economic Stimulus Payments Help the Economy?)
But, in late September 2008, it became clear that, despite the government’s attempts
to stimulate the economy through tax cuts, economic conditions had worsened. The collapse of the subprime mortgage industry had escalated into a full-blown financial crisis
necessitating government action. To address this situation, the Bush administration proposed a $700 billion federal bailout package. The plan was intended to reassure the
financial markets by allowing the government to buy up the assets that had led to the
crisis. This was known as the Troubled Assets Relief Program (TARP) and the monies
as TARP funds.
The first version of the bailout plan failed to gather enough votes in the
House of Representatives, forcing frenzied rounds of House and Senate negotiation. Efforts were made to make the plan more palatable to politicians up for
reelection who were facing constituents overwhelmingly opposed to using taxpayer funds for bailing out Wall Street. President George W. Bush, members of
his administration, and congressional leaders sought to present the financial
bailout plan as an economic rescue plan. They emphasized the extent to which
financial collapse on Wall Street and virtually frozen credit markets would affect
the ability of those on Main Street to do business, refinance their homes, or buy a
car. As a result of these efforts, ConHow did the government take action to stimulate the economy in 2009? One
gress passed a modified version of the
program offered an $8,000 tax credit to first-time homebuyers.
administration’s initial bailout plan
known as the Emergency Economic
Stabilization Act in October 2008. It
provided enhanced oversight of the
Treasury Department’s use of the $700
billion, an option to use the money to
buy equity stakes in faltering banks,
some protection to those in danger of
losing their homes, and a variety of tax
cuts and incentives.
Although the TARP funds helped to
stabilize American banks, individuals were
still struggling with the economic downturn. After he took office in early 2009,
one of the first priorities of President
Barack Obama was to address this situation by working with Congress to pass an
economic stimulus and recovery bill, the
American Recovery and Reinvestment
Join the DEBATE
Do Economic Stimulus Payments
Help the Economy?
In early 2008, the economy was in decline. Workers were losing their jobs, consumer spending was
going down, and families were unable to make mortgage payments and were losing their homes. In an
attempt to keep the economy from going into a full-blown recession, the U.S. government agreed to
fund a $168 billion stimulus package that included individual tax rebates. Most citizens who received a
check got $600 if they filed individually, or $1,200 if they filed jointly.
The political calculus for sending money back to taxpayers seemed clear. Policy makers were
signaling to their constituents that they were concerned and doing something to improve the economy
generally and the fate of individuals specifically. The economic calculus, however, was less clear. How
far would a $600 check go in stimulating growth in jobs and businesses? Would consumers use the
money to stimulate the economy by buying new cars or kitchen appliances? Or, would people save their
checks or use them to pay off existing debt instead?
■
■
■
The government has a responsibility to prevent
economic downturns. Who would act to prevent
recessions and inflation, if not the government? What
are the potential consequences of the government taking a “wait and see” approach during a recession?
Economic stimulus efforts have the greatest impact on
low- and middle-income families, which are hardest
hit during a recession. How do low-and middleincome families benefit from economic stimulus payments? How might these families assist in turning
around a troubled economy?
Stimulus payments send a powerful message to
consumers, businesses, and investors. How might
a stimulus payment help to restore consumer
confidence? In what ways do stimulus payments
provide corporations with incentives to increase
production and forestall layoffs?
Can economic stimulus payments fuel a troubled
economy? Economists disagree on the ability of economic
stimulus payments, such as tax rebates, to right an economy
on a collision course with itself.
To develop an ARGUMENT AGAINST economic
stimulus payments, think about:
■
■
■
The government should not interfere with market
forces. How does the artificial injection of spending
money by the government divert attention from real
economic problems? Do stimulus checks only prolong
the inevitable?
Deficit spending—spending more money than is available—has serious future ramifications. In what ways is
it irresponsible for the government to go into debt that
will last for hundreds of years in order to prevent a
short recession? What will be the long-term
ramifications of this spending?
Government cannot control how stimulus payments
are used. Will low- and middle-income families use
their stimulus checks to pay for necessities, or for additional purchases that will stimulate the economy? If the
money is spent on necessities, how will businesses be
helped and jobs generated?
Photo courtesy: Used with the permission of Clay
Bennett, the Washington Post Writers Group and
the Cartoonist Group. All rights reserved.
To develop an ARGUMENT FOR economic
stimulus payments, think about:
595
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CHAPTER 18
Economic Policy
Figure 18.6 Where did the economic stimulus funds go?
The American Recovery and Reinvestment Act allocated almost $800 billion to aid in the
economic recovery. The largest proportion of these funds—more than one-third—went to tax cuts.
Source: U.S. Government, www.recovery.gov.
Housing $12.7 (1.6%)
Science $8.9 (1.1%)
Other $18.1 (2.3%)
Energy $61.3
(7.7%)
Infrastructure
$80.9
(10.2%)
Low-Income
Aid
Tax Cuts
$288 (36.4%)
$82.5
(10.4%)
$90.9
(11.5%)
Education
Health Care
$147.7
(18.7%)
Recovery Funds (in Billions)
Act. This legislation authorized the government to spend more than $787 billion on a
variety of tax cuts and public works programs designed to stimulate the economy and to
maintain and create jobs in transportation, education, health care, and other industries.
These funds have been widely distributed across the country. In order to
enable citizens to better understand where and how their stimulus funds are being
spent, the Obama administration established a Web site, www.recovery.gov. The
administration also created a logo for the recovery program, which it uses on public works projects, in order to provide visible signs of the government’s efforts to
end the economic slowdown. (To learn more about where the stimulus funds
went, see Figure 18.6.)
Monetary Policy
Monetary policy is often the preferred way to address an economic crisis, in part
because it can be easily implemented and has fewer long-term financial consequences than the deficit spending typified by fiscal policy and the Recovery Act. In
early 2008, the Federal Reserve Board responded quickly to the economic slowdown, taking extraordinary action to lower interest rates and engaging in large
open-market operations and discount rate reductions to increase liquidity in the
markets. In March 2008, the Fed also injected about $200 billion into the U.S.
banking system by offering banks low-interest, one-month loans to ease the tightening credit conditions. It later took action to adjust mortgage lending rules and
expand the commodities that U.S. markets could borrow against in order to increase
the supply of money in the market.
Despite signs of an economic recovery in early 2010, the Fed has continued to
keep interest rates low in the hopes of attracting borrowers who will inject money into
Toward Reform: Recession and Economic Recovery
the market. Projections following the September 2010 meeting of the Fed indicated
interest rates would not be raised until early 2011.
Income Security Policy
The worsening economic conditions and rising unemployment have put pressure on
the national and state governments to continue to administer income security programs, even as their rolls have grown rapidly. The number of enrollees in the Supplemental Nutrition Assistance Program reached record levels in 2010. In the state of
Michigan, for example, one in every eight residents was enrolled in the program.20
Economists, furthermore, estimate that there are thousands more Americans who are
eligible for the program but have not enrolled.
The most severe consequences of this growth are for state budgets and the
national deficit and debt. Recall that states must have balanced budgets—the
amount of revenues must be equal to or greater than expenditure levels. Thus, as
the rolls for programs such as unemployment insurance and food stamps rise, state
costs to administer these programs—and therefore, projected expenditures—rise
rapidly. At the same time, however, state revenues in the form of income and sales
taxes decline as a result of fewer workers and lower consumer spending. This combination has placed great pressure on state governments. Many states have had to
find creative ways to raise revenue or make large budget cuts in other areas in order
to make ends meet.
For its part, the national government has engaged in deficit spending in order to
fund these and other programs, as well as to help states balance their budgets. The
costs of these expenditures will not be fully realized for years, as the nation faces a
growing national debt and the threat of economic instability from owing large sums
of money to creditors. As the economy recovers, the national government will also
have to deal with questions regarding the financial insolvency of Social Security and
other programs.
Evaluating the Government’s Response
Signs of the economic downturn—and the ultimate collapse of the financial institutions—were severe enough that both Republicans and Democrats agreed on the need
to act to forestall long-term consequences, both for individuals and the nation at large.
It is, however, worth noting that both parties encouraged responses to the economic
collapse that were consistent with their political and economic worldviews. Seeing the
signs of a downturn in early 2008, for example, President George W. Bush and the
Republican Party urged the Fed to take action to increase the supply of money and
lower interest rates. The Bush administration also worked with Congress to pass a tax
rebate to put more money in citizens’ pockets. After taking office in 2009, however,
the Democrats, led by President Barack Obama, wasted little time implementing a
Keynesian deficit spending approach through the Recovery Act.
As the economy recovers, economists will debate which of these policy
approaches was most effective. Not surprisingly, assessments generally break down on
partisan lines. White House economists, for example, credit the Recovery Act for
bringing about economic growth and stalling a rise in unemployment in late 2009 and
early 2010. Conservative scholars and former Republican governmental officials do
not dispute this growth, but they argue that it is the result of monetary policy and
decisive bailout actions through the TARP program.21
597
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CHAPTER 18
Economic Policy
In all likelihood, however, both fiscal and monetary policy, as well as the safety net
provided by national and state income security programs, have helped to improve the
American economy. It is the government’s responsibility to take decisive action in all
three areas: fiscal, monetary, and income security policy, to prevent or reduce the
impact of future downturns in the business cycle.
What Should I Have LEARNED?
Now that you have read this chapter, you should be able to:
18.1 Trace the evolution of economic policy in the
United States, p. 570.
18.3 Analyze the effect of the Federal Reserve
System on monetary policy, p. 583.
The government’s role in regulating the economy has
evolved over the nation’s history. During the nineteenth
century, the national government defined its economic role
narrowly and subscribed to a laissez-faire economic
philosophy. By the 1890s, however, it became clear that the
national government needed to take greater steps to
regulate the economy, which it did by creating the
Interstate Commerce Commission and passing antimonopoly legislation. Later, to help bring the nation out of
the Great Depression, President Franklin D. Roosevelt’s
New Deal in the 1930s brought increased government
intervention in a number of economic policy areas
including financial markets, agriculture, labor, and industry.
In the 1960s and 1970s, the government expanded its role
to include social regulations dealing with health, safety, and
environmental protection. Finally, at the end of the
twentieth century, a backlash occurred against regulation,
and deregulation, or the reduction in market controls in
favor of market-based competition, gained prominence.
Monetary policy is a form of government regulation in
which the nation’s money supply and interest rates are
controlled. The Federal Reserve System (“the Fed”) was
created in 1913 to adjust the money supply to the needs of
agriculture, commerce, and industry. Today, it handles
much of the day-to-day management of monetary policy.
It has a number of tools to aid its efforts, including the
ability to set reserve requirements, or government
requirements that a portion of member banks’ deposits be
retained as backing for their loans; control of the discount
rate, or the rate of interest at which the Federal Reserve
Board lends money to member banks; and open market
operations, which involve the buying and selling of
government securities by the Federal Reserve Bank in
the securities market.
18.2 Assess the impact of the budget process on
fiscal policy, p. 577.
Fiscal policy is the deliberate use of the national
government’s taxing and spending policies to maintain
economic stability. Fiscal policy is influenced by many
factors, including the global economy, which can affect
income levels for American workers and increase
international interdependence. The federal budget is one of
the primary tools of fiscal policy; it can be manipulated to
stabilize the economy and to counteract fluctuations in
federal revenues. Except for a short period from 1998 to
2001, the federal government has generally run a budget
deficit, which can have negative consequences for the
economy over the long term.
18.4 Describe the evolution of income security
policy in the United States, p. 586.
Income security programs protect people against loss of
income. Income security policy was not a priority for the
federal government until the 1930s, when it passed the
Social Security Act. Today, the federal government
administers a range of income security programs that fall
into two major areas: non-means-tested and means-tested
programs. Non-means-tested programs are programs that
provide cash assistance to qualified beneficiaries regardless
of income; they include old age, survivors, and disability
insurance, and unemployment insurance. Means-tested
programs require that people have incomes below specified
levels to be eligible for benefits; they include Supplemental
Security Income (SSI), family and child support, the
Earned Income Tax Credit (EITC), and the Supplemental
Nutrition Assistance Program (food stamps).
Test Yourself: Economic Policy
18.5 Evaluate the role of fiscal, monetary, and
income security policy in the economic recession and
recovery, p. 593.
By the end of 2008, the nation was in a full-blown recession,
a decline in the economy that occurs as investment sags,
production falls off, and unemployment increases. The
national government identified the crisis situation quickly
and took a number of actions to restart economic growth and
stimulate the economy through the use of fiscal, monetary,
and income security policy. In terms of fiscal policy, the Bush
administration offered tax rebates and proposed a $700
599
billion federal bailout package for the banking industry
known as TARP. When President Barack Obama took
office, he worked with Congress to pass the $787 billion
American Recovery and Reinvestment Act to help stimulate
the economy and to maintain and create new jobs. In terms
of monetary policy, the Federal Reserve Board responded
to the crisis by cutting interest rates and engaging in open
market operations and discount rate reductions. The costs
of income security programs during this economic downturn
have put a strain on both national and state budgets.
Test Yourself: Economic Policy
18.1 Trace the evolution of economic policy in the
United States, p. 570.
18.4 Describe the evolution of income security policy
in the United States, p. 586.
Through the 1950s, most regulatory programs enacted by
the national government fell into the category of ________
regulation.
A. monetary
B. social
C. economic
D. preemptive
E. adjudicative
Income security programs intended to assist persons whose
income falls below a designated level are called
A. security assistance laws.
B. social insurance statutes.
C. means-tested programs.
D. non-means-tested programs.
E. Medicare and Medicaid.
18.2 Assess the impact of the budget process on
fiscal policy, p. 577.
When Congress does not complete its appropriations
process by the end of the fiscal year, it usually
A. shuts down the government.
B. passes a continuing resolution.
C. sells additional bonds.
D. asks the president for an extension of the fiscal year.
E. increases taxes until the appropriations have been
paid in full.
18.3 Analyze the effect of the Federal Reserve System
on monetary policy, p. 583.
The portion of a bank’s deposits that the bank must retain as
backing for its loans is known as the
A. loan requirement.
B. reserve requirement.
C. financial backing proportion.
D. earnest money.
E. fiduciary responsibility.
18.5 Evaluate the role of fiscal, monetary, and
income security policy in the economic recession and
recovery, p. 593.
Much of the current economic downturn is attributable to
A. the cost of the war in Iraq.
B. automobile loans.
C. the cost of No Child Left Behind.
D. the cost of presidential campaigns.
E. the subprime mortgage crisis.
Essay Questions
1. What is deregulation, and why did it become popular in
the 1970s and 1980s? What impact has it had on the
American economy?
2. What is the role of Congress in making the federal budget?
3. What is the Federal Reserve System, and how does it
regulate U.S. monetary policy?
4. What types of non-means-tested income security
programs does the government provide?
5. How has the government used fiscal and monetary
policy to help overcome the recent economic downturn?
600
CHAPTER 18
Economic Policy
Exercises
Apply what you learned in this chapter on MyPoliSciLab.
Read on mypoliscilab.com
Explore on mypoliscilab.com
Simulation: Making Economic Policy
Simulation: You Are the President and Need to Get a
Tax Cut Passed
Comparative: Comparing Economic Policy
Timeline: Growth of the Budget and Federal
Spending
Visual Literacy: Evaluating Federal Spending and
Economic Policy
Visual Literacy: Where the Money Goes
eText: Chapter 18
Study and Review on mypoliscilab.com
Pre-Test
Post-Test
Chapter Exam
Flashcards
Watch on mypoliscilab.com
Video: Recession Hits Indiana
Video: The Stimulus Breakdown
Video: Economic Policy Debate at the G20
Video: Fed Approves Mortgage Crackdown
Key Terms
Board of Governors, p. 584
budget deficit, p. 583
business cycles, p. 571
deregulation, p. 576
discount rate, p. 586
economic regulation, p. 575
economic stability, p. 593
entitlement programs, p. 588
fiscal policy, p. 577
gross domestic product (GDP), p. 579
inflation, p. 583
interventionist state, p. 573
laissez-faire, p. 570
means-tested programs, p. 588
monetary policy, p. 583
non-means-tested programs, p. 588
open market operations, p. 586
recession, p. 593
reserve requirements, p. 586
social regulation, p. 575
Social Security Act, p. 588
To Learn More on Economic Policy
In the Library
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Fleckenstein, William, and Fred Sheehan. Greenspan’s Bubbles:
The Age of Ignorance at the Federal Reserve. New York: McGraw
Hill, 2008.
Hacker, Jacob S. The Great Risk Shift: The New Economic Insecurity
and the Decline of the American Dream. New York: Oxford
University Press, 2008.
Keech, William. Economic Politics: The Costs of Democracy.
Cambridge, MA: Cambridge University Press, 1995.
Kettl, Donald F. Deficit Politics: Public Budgeting in Its Institutional
and Historical Context, 2nd ed. New York: Longman, 2010.
Lee, Robert D., Ronald W. Johnson, and Philip G. Joyce.
Public Budgeting Systems, 8th ed. Boston: Jones and Bartlett,
2007.
Miller, Roger LeRoy, Daniel K. Benjamin, and Douglass C. North.
The Economics of Public Issues, 16th ed. New York: Addison
Wesley, 2009.
Page, Benjamin I., and Lawrence R. Jacobs. Class War: What
Americans Really Think About Economic Inequality. Chicago:
University of Chicago Press, 2009.
Phillips, Kevin. Wealth and Democracy: A Political History of the
American Rich. New York: Broadway, 2002.
Rubin, Irene S. The Politics of Public Budgeting: Getting and
Spending, Borrowing and Balancing, 5th ed. Washington, DC:
CQ Press, 2005.
Rubin, Robert E., with Jacob Weisberg. In an Uncertain World:
Tough Choices from Wall Street to Washington. New York:
Random House, 2003.
To Learn More on Economic Policy
Schiff, Peter D. How an Economy Grows and Why It Crashes.
New York: Wiley, 2010.
Schiller, Robert. Irrational Exuberance. Princeton, NJ: Princeton
University Press, 2000.
Sheehan, Frederick. Panderer to Power: The Untold Story of How
Alan Greenspan Enriched Wall Street and Left a Legacy of
Recession. New York: McGraw Hill, 2009.
Stiglitz, Joseph, and Linda Bilmes. The Three Trillion Dollar
War: The True Cost of the Iraq Conflict. New York:
Norton, 2008.
Tietenberg, Tom, and Lynne Lewis. Environmental Economics and
Policy, 6th ed. New York: Prentice Hall, 2009.
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On the Web
To learn more about the Bureau for Economic Analysis, go to its
Web site at www.bea.doc.gov.
To learn more about current fiscal policy, go to www.gpoaccess.
gov/usbudget/index.html.
To learn more about regulation of financial markets, go to the
Federal Reserve Board Web site at www.federalreserve.gov.
To learn more about Social Security, go to the Social Security Web
site at www.ssa.gov.