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Wages are sticky Thrift is paradoxical Money multiplies Produce so we buy Recessions are natural Equilibrium Animal spirit The multiplier effect Start spending right now government spending stimulates economy awesome in short term Flexible prices Recessions are natural Equilibrium Not one thing is ever free Let the prices work People pretend to know things Economic Policy Day 1 Objectives: 1.Identify phases of business cycle. 2.Develop an economic policy for various episodes in history. 3.Make conclusions as to why different episodes may necessitate different policies. EQ 4-8 How should the government carry out its economic role to accomplish the goals of full employments, increased production, and stable prices? Why is this question difficult to answer? EQ 4-8 Which philosophy wins? Why? Fiscal Policy (Demand side) Who- Congress What- increasing or decreasing spending and Revenue (taxes) Goal- Impact Aggregate Demand - full employment, stability, and growth Keynesian economics President sets the budget, Congress develops programs- they can tax and borrow Commerce clause – etc. Raising Revenue- Tax or Borrow Spending- increase of Decrease (discretionary and nondiscretionary) Will impact C and G Monetary Policy (Demand side) Who- the Federal Reserve What- increasing or decreasing the amount of money in circulation Goal- full employment, stability, and growth Easy Money Supply- increasing money supply and decreasing interest rates Open Market OperationsDiscount RatesReserve Requirements- buy securities lower discount rate lessen requirements Tight Money Supply – decreasing the money supply and increasing interest rates Open Market operationsDiscount RatesReserve RequirementsWill impact I and C and G sell securities increase discount rates increase requirements How to fix the economy? According to . . . Fiscal Policy Increase Government Spending During a Recession With high unemployment Decrease Taxes Deficit spending is acceptable During Expansion Let Tax breaks expire or increase tax Supply Side Policy Easy $ Cut tax on Business Buy Securities from banks Reduce Regulation or dealers Decrease Discount Rate Decrease Government Spending With high inflation Monetary Policy Reduce Reserve requirements All ideas intended to lower interest rate Tight $ Sell securities to banks Increase Discount Rate Increase Reserve Requirements All ideas intended to increase interest rates Give business a chance to expand and hire No capital gains tax or marginal (progressive income tax) Do nothing the market will take care of itself. Inflationary and Recessionary Gaps- Steering the Market Economic Activity Potential GDP Inflationary Gap (Full Employment) Recessionary Gap Time (years) The Government can steer the economy in different ways 1. Laws and Regulations- stabilizers 2. Fiscal Policy- changes in government spending or taxation to influence the economy 3. Monetary policy- changes in monetary supply to influence the interest rates that influence economy Summary Recessionary Gap Actual GDP < Potential GDP Output is below full employment High unemployment Government wants to limit unemployment by increasing demand Fiscal Policy: Gov’t can increase gov’t spending or decrease tax on consumers. AD = C + I + G + NE Monetary Policy: Federal Reserve can increase money supply or decrease interest rates. AD = C + I + G + NE Summary Inflationary Gap Actual GDP > Potential GDP Output is beyond full employment Unemployment very low Prices very high Government wants to limit inflation by reducing demand Fiscal Policy: Gov’t can decrease gov’t spending or increase tax on consumers. AD = C + I + G + NE Monetary Policy: Federal Reserve can decrease money supply or increase interest rates. AD = C + I + G + NE Deficit Spending- annually – When the government spends more that it brings in as tax revenue. Deficits make good politics, why? It is popular to cut taxes and to increase spending. How do we pay for the deficit? Borrowing Debt- Accumulation of Deficits over the years Surplus- when Revenue exceeds spending (annually) Choose your own Policy You and your group have been hired by a well-known economic think tank. Your think tank is famous for developing and publishing economic policies that are often adopted by the government as official policy. Although you do this every year, the government and the public take a specific interests in what you propose during periods of economic uncertainty. First, the only information that you will have at your disposal is data from the 3 main indicators of GDP, unemployment rate, and inflation rate. Second, you and your group have to uphold the reputation of the think tank by only making suggestions that fall under 1 of the 3 categories below. It is also acceptable to create a policy that is a combination of the three. Remember the overall goals of any economic policy; lower unemployment, growth, stable prices, and improved standards of living. a. Fiscal Policy- Congressional economic policy dealing with spending and taxation. How much Congress spends and how and who they tax will have an impact on over-all GDP. b. Monetary Policy- Federal reserve policies that involve increasing or decreasing the amount of money available to spend or borrow. c. Do nothing- take a hands off approach, this includes letting individuals succeed and fail. d. Supply-side – create policy that boost Aggregate supply I will act simply as a consultant to you and your group. I will present data and information regarding the time period. Additionally, I will provide you with some clarity on how policies that are intended to impact one indicator can and will impact other indicators as well. A demand side approach is intended to impact aggregate demand and therefore impact price levels, spending, GDP, and employment Examples: taxes, spending, and monetary policy Expansionary policy intended to boost GDP and/or lower unemployment rates may result in higher prices. When the “bubble” becomes too inflated it burst and we get recession. Examples: Cutting taxes, increasing government spending, increasing money supply, and lowering interest rates. Contractionary policy or policy intended to slow the rate of inflation have a tendency to lower aggregate demand and thus lower production needs and the use of resources (this includes labor). Examples: increasing taxes, cutting government spending, decreasing money supply, increasing interest rates A supply-side approach is intended to impact aggregate supply and therefore lower prices, which will in turn boost demand and decrease unemployment. Examples: cutting taxes on business, increasing education, increasing technology, removing regulations, and removing barriers of entry. Scenario Great Depression 1930’s Indicators from year to year Up or down? 5 year trend GDP Economic Policy Economic Goal for year 6? Main Economic goals moving forward? Stable prices, unemployment, growth? % of GDP that is G spending? Unemployment rate Policy? What are the intended outcomes? inflation rate? Is your policy demand side or supply side? Explain your logic What is happening in year 5? Late 1940’s Early 1950’s 5 year trend GDP Economic Goal for year 6? Main Economic goals moving forward? Stable prices, unemployment, growth? % of GDP that is G spending? Unemployment rate inflation rate? Policy? What are the intended outcomes? Is your policy demand side or supply side? Explain your logic What is happening in year 5? Late 1970’s 5 year trend GDP % of GDP that is G spending? Unemployment rate Economic Goal for year 6? Main Economic goals moving forward? Stable prices, unemployment, growth? Policy? What are the intended outcomes? inflation rate? What is happening in year 5? Today 2007-2013 5 year trend GDP Is your policy demand side or supply side? Explain your logic Economic Goal year 6? Main Economic goals moving forward? Stable prices, unemployment, growth? % of GDP that is G spending? Unemployment rate Policy? What are the intended outcomes? inflation rate? Is your policy demand side or supply side? Explain your logic What is happening in year 5? 1929- 1933 The beginning to the Great Depression The overall size of the American economy, measured by gross domestic product, sharply declined following the crash on Wall Street—from $103.6 billion in 1929 to $66 billion in 1934. Full and healthy employment in 1929 at 3.2% abruptly shifted with the crash on Wall Street and ensuing global depression. Rising unemployment reached doubledigits in late 1930, and the situation continued to deteriorate through the bleak winter of 193233, when well over a quarter of all workers were unable to find jobs. Average Annual Inflation Rates: What did the Government decide to do? FDR and the Congress passed New Deal Measures that called for an increased government spending and government projects. The economic recovery of 1933-1937, among the most dramatic in US history, saw double-digit annual gains, although a tax increase and cutback in government spending in 1937 threw the economy back into recession. Complete recovery from the economic misery of the Great Depression only arrived after 1940, when mobilization for World War II caused a huge increase in industrial production; between 1940 and 1945. Franklin Roosevelt's New Deal greatly increased the size and scope of government during the 1930s, then World War II increased government spending even more dramatically in the early 1940s, skyrocketing to consume nearly half the US economy during World War II. The New Deal helped to reduce unemployment from 1933 through 1937, when another economic recession briefly caused a resurgence in joblessness. Full employment did not return until the war years of the early 1940s. 1930’s and 1940’s Great Depression Increase Government Spending to boost Aggregate Demand Who Wins? Keynesian economics or Classical economics Late 1940’s to the early 1950’s Inflation was an important issue during the 1950s because of two major waves of inflationary conditions swept the country at this time. The first followed the end of World War II and the second at the onset of the Korean War in 1950. Post World War II America waited expectantly for the United States to suffer a postwar economic collapse. The recession came in the third quarter of 1948 and lasted until the second quarter of 1950. The causes of this inflation are not fully understood. Slow economic growth and slow increases in the money supply are considered the most probable culprits. At this time the money supply rose much more slowly than the Gross Domestic Product. Average Annual Inflation Rates: What did the Government decide to do? The economy overall grew by 37% during the 1950s. At the end of the decade, the median American family had 30% more purchasing power than at the beginning. Inflation, which had wreaked havoc on the economy immediately after World War II, was minimal, in part because of Eisenhower's persistent efforts to balance the federal budget. Except for a mild recession in 1954 and a more serious one in 1958, unemployment remained low, bottoming at less than 4.5% in the middle of the decade. Many factors came together to produce the Fifties boom. The G.I. Bill, which gave military veterans affordable access to a college education, added a productive pool of highly-educated employees to the work force at a time American businesses were willing to pay handsomely for engineering and management skills. Cheap oil from domestic wells helped keep the engines of industry running. Advances in science and technology spurred productivity. At the same time, potential competitors in Europe and Asia were still recovering from being bombed into smithereens during World War II. Eisenhower attempted to balance the budget while keeping some New Deal policies. Policies to promote private growth were emphasized. Government programs such as the highway act were developed. Stagflation and the 1970’s By the time that Jimmy Carter took office, the US economy was well into a cyclical expansion, but Carter, after replacing Arthur Burns as Fed chairman with the clueless G. William Miller, encouraged Miller to continue a policy of rapid monetary expansion, producing rising inflation in 1977 and 1978. Once again, unnecessary monetary stimulus produced rising inflation and rising inflation expectations just before a second oil-price shock, precipitated by the Iranian Revolution, began in 1979. The combination of rising inflation expectations and rapidly rising oil prices (exacerbated by the continuing controls on petroleum pricing causing renewed shortages of gasoline and other refined products) caused a leftward shift in aggregate supply, causing inflation to rise while output fell. Hence the second episode of stagflation. Average Annual Inflation Rates: What did the Government decide to do? Reagan (1981-1989) based his economic program on the theory of supply-side economics, which advocated reducing tax rates so people could keep more of what they earned. Supply-side economics is a school of macroeconomics that argues that economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as lowering income tax and capital gains tax rates, and by allowing greater flexibility by reducing regulation. According to supply-side economics, consumers will then benefit from a greater supply of goods and services at lower prices. Typical policy recommendations of supplyside economists are lower marginal tax rates and less regulation. There is was an initial recession in 1982 but by the middle of the 1980’s inflation rates were dramatically cut while GDP increased. By the late 1980’s unemployment dropped to the NRU. Supply-side Economics Supply-side economist believe that economic growth is driven by increasing aggregate supply. By increasing supply, prices drop Law of demand: Lower Prices increase the Quantity Demanded Wealth is created and standards of living increase not because we demand but because we produce. As suppliers produce more, prices lower. As price lowers, the quantity demanded increased. Suppliers will need to supply more and this gives them more money to spend on other goods and services. 3 main methods: 1. Lower taxes on employers, employees, and those who invest in business expansion. 2. Remove unnecessary regulations that prevent efficiency, restrict competition, and promote artificial scarcity. This will also have the secondary effect of decreasing the size of government. 3. Monetary policy- the Federal Reserve needs to adopt Milton Friedman’s money supply rule. a. Increase labor market flexibility- Lower min. wage, Weaken trade unions, Reduce unemployment benefits b. Invest in education c. Advancements in technology – lowers production cost and creates new markets d. Lower income tax and capital gains tax- eliminate progressive tax (marginal tax rates) e. Lower corporate tax rates f. Invest in infrastructure g. reduce regulations and oversight h. Remove barriers of entry (licenses, certs. Etc.) Concerns: Pollution, people will take advantage of others without government regulations, less government revenue, and tax cuts will only help the rich. How to fix the economy? According to . . . Fiscal Policy Increase Government Spending During a Recession With high unemployment Decrease Taxes Deficit spending is acceptable During Expansion Let Tax breaks expire or increase tax Supply Side Policy Easy $ Cut tax on Business Buy Securities from banks Reduce Regulation or dealers Decrease Discount Rate Decrease Government Spending With high inflation Monetary Policy Reduce Reserve requirements All ideas intended to lower interest rate Tight $ Sell securities to banks Increase Discount Rate Increase Reserve Requirements All ideas intended to increase interest rates Give business a chance to expand and hire No capital gains tax or marginal (progressive income tax) Do nothing the market will take care of itself. 1970’s Stagflation – high unemployment and high inflation. 1980’s Supply-side economics Who Wins? Keynesian economics or Classical/Austrian economics 2008 Due to mortgage foreclosures and the bubble bursting on the housing market, many majors banks in the United States were on the edge of failure. This started a downward spiral that impacted numerous markets including the auto markets. Biggest problems: Potential Bank Failure of major Wall street banks Potential Some Auto companies filing for bankruptcy High unemployment rates Average Annual Inflation Rates: Deflation What would Keynes suggest? What would Hayek suggest? What caused it? What would Keynes agree with? What would Hayek agree with? 1. Low interest rates prevented savings and led to no real production. Hayek 2. Poor practices from the lending industry caused by their selfishness. Keynes 3. Poor practices from the lending industry caused by government laws and cronyism. Hayek 4. Risky behavior caused by the assumption that government would Hayek provide a safety net. 5. Low interest created malinvestments. 6. Tax cuts that led to two unfunded wars. Hayek Keynes 2008- 2013 The Great Recession and Less than Great Recovery Due to mortgage foreclosures and the bubble bursting on the housing market, many majors banks in the United States were on the edge of failure. This started a downward spiral that impacted numerous markets including the auto markets. In October of 2008, President Bush and the Congress bailed out the some wall street banks with tax payer’s money. The Troubled Assets Relief Program (TARP) bailed out the banks by buying their subprime mortgages. In the spring of 2009, President Obama and the Congress bailed out some specific car companies. This kept them afloat and allowed them to avoid bankruptcy. It was explained to the American people that both the Wall street banks and General Motors were “too big to fail.” Also in 2009, the American Recovery and Reinvestment Act was proposed by President Obama and passed by Congress. Over $803 billion dollars were spent to increase GDP and lower unemployment. The following year, The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was passed. This was a combination of tax breaks for the middle class and payroll tax. Also an extension of federal unemployment benefits. Very slow growth 1948-57: 3.80% 1958-67: 4.28% 1968-77: 3.18% 1978-87: 3.15% 1988-97: 3.05% 1998-2007: 2.99% 2008-2013: 0.73% 2008-2014 Great Recession Leads to the Stimulus Package- $831 Billion 2010-2014 Slow recovery – businesses are not producing Who Wins? Keynesian economics or Classical/Austrian economics EQ 4-8 How should the government carry out its economic role to accomplish the goals of full employments, increased production, and stable prices? Why is this question difficult to answer? EQ 4-8 Which philosophy wins? Why? Day 2 Objectives: 1. Evaluate the effectiveness of policies today 2. Develop arguments for Keynes and Hayek Stimulus 2009 develop Keynes arguments for Hayek’s arguments against EQ 4-8 How healthy is the U.S. economy today? Has government policy helped or hurt our economy? EQ 4-10 To what extent can the statement, “there is nothing without costs” be applied to government policies? Why was our Recovery so slow? Create an argument that Keynes would use in a debate. Create an argument that Hayek would use in a debate? Fallacies Aggregate markets Fiscal and monetary policy Video Clips for Presentation Stimulus Hearing 19:12- 22:10 Economist Against Stimulus Package 45:45- 51:38 Economist speaking about net gain of Stimulus Package 1:32:30- 1:36:00. Economist in favor of the Stimulus Package Hayek vs Keynes Raps Fight of Century Keynes vs. Hayek Round 2 Are their arguments for and against similar to your arguments? Make a check mark next to your arguments that the economists speak about. Why was our Recovery so slow? What would Keynes and Hayek say? 1. We didn’t spend enough. Keynes 2. Government spending is inefficient and suffers from lag, also it didn’t help those who needed it the most. Hayek 3. Mixed messages from the government such as threats to increase minimum wage and healthcare prevents growth. Hayek 4. Low interest created malinvestments and it will do it again. Hayek 5. Opposition with the other party prevented all important government action to get through. Keynes 6. To think that people in government know how to direct our resources better than people in the private sector such as Steve Jobs or Bill Gates is crazy. Hayek 7. The great recession was much worse than we thought. Keynes Explanations for slow recovery 1. 2. 3. 4. We underestimated the extent of the recession. We should have spent more. (more demand side) Government needed to get more involved Businesses are moving overseas Or 1. We overestimated government’s ability to fix the economy 2. We spent money on the wrong places. 3. Legislation such as the Affordable care act and Green Energy are causing businesses to put off growth due to uncertainty. Policies are impacting supply and creating an artificial scarcity. 4. Bailouts waste resources and don’t allow growth. EQ 4-8 How healthy is the U.S. economy today? Has government policy helped or hurt our economy? What would Keynes say? What would Hayek say? What do you think? EQ 4-10 To what extent can the statement, “there is nothing without costs” be applied to government policies? Day 2 Objectives: 1. Compose your own creative expression. 2. Incorporate economic ideas from unit 4 Formative Quiz 1. According to Keynes what must happen to Aggregate Demand in order to get out of a recession? 2. What is fiscal policy and who conducts fiscal policy? 3. According to Keynes what is the proper fiscal policy during recession? 4. According to Keynes what is the proper fiscal policy during inflationary periods? 5. What is monetary policy and who conducts monetary policy? 6. According to Keynes what is the proper monetary policy during recession? 7. According to Keynes what is the proper monetary policy during inflationary periods? Progressive Tax Laffer Curve Friedman’s solution to the problems of INFLATION and short-run fluctuations in employment and real GDP was a so-called money-supply rule. If the Federal Reserve Board were required to increase the money supply at the same rate as real GDP increased, he argued, inflation would disappear. When money supply exceed GDP growth = Prices rise When money supply is less than GDP growth = Prices fall Money Supply Rule Money Supply increases at the same rate as GDP growth "In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian."- Milton Friedman What do you think Friedman means in the red and the in the black? Now its your turn to be creative!!!! These may be performed after the Quiz and/or the day after the quiz. Hailey Caracio adapted a famous sonnet Shall I compare thee to a summer's day - Shakespeare Shall I compare thee to the yearly Gdp? Thou art more prosperise and high Rough times do shake the darling rise of GDP And recession all too long to a date Sometimes all to low the GDP shines And too often is his yearly spending dimm'd And every year from year sometimes declines by chance or mans changing course untrimm'd By thy eternal worth shall not fade Nor loose value of that fair thou worth Nor shall depression brag thou wander'st in his shade When in eternal worth to time thou growest so long as men can spend or men produce So long lives spending and this gives life to GDP Keynes and Hayek Keynes says prices are sticky. But, Hayek thinks, when allowed, they're flexible. When their jobs are at risk, it's better to keep your job than be picky. Eventually the markets will reach equilibrium and become stable. Is it better to boost aggregate demand or let supply create demand? Do you involve the Congress or the Fed? Hayek wants the economy to move with the help from the Invisible Hand. He knows you can't just know people's motivation with just your head. Start spending now, in the long run, we're all dead. Money's impact on the economy will multiply. That's what Keynes said. All the government has to do is try. There are many opinions on how to deal with recessions and inflation? Maybe a balance of Keynes and Hayek would be best for the nation.