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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. 569 570 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. 573 CHAPTER 18 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 574 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. 576 CHAPTER 18 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. 578 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. 580 CHAPTER 18 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.) 581 582 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 CHAPTER 18 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 CHAPTER 18 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” 587 588 CHAPTER 18 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 589 590 CHAPTER 18 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 591 592 CHAPTER 18 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. 594 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: 595 596 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.21 597 598 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 Chernow, Ron. Alexander Hamilton. New York: Penguin, 2004. 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. 601 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.