Download Measuring Unemployment Measuring Unemployment (cont.)

Governments strive for a balance
between the costs and benefits of
their economic policies to promote
economic stability and growth.
Is an unemployment rate of 5%
acceptable?
A. Yes
B. No
C. Not sure
Measuring Unemployment
A. A
B. B
C. C
Measuring Unemployment (cont.)
Unemployment can be classified as
cyclical, structural, seasonal, or
frictional.
• The federal government uses stabilization
policies to keep the economy healthy and
includes monetary and fiscal policies.
NOTE: You will need to know the
differences between these!
• The unemployment rate is one statistic
that all economists look at. It is a
percentage of the civilian labor force that is
unemployed but is actively looking for work.
View: Measuring Unemployment
One of the major goals in stabilizing the national
economy is maintaining a low unemployment
rate. Economists classify unemployment as one
of four types.
• Many types of
unemployment
exist, so not all
unemployment
can or should
be eliminated.
Measuring Unemployment (cont.)
• Economists generally consider the
economy at full employment when the
unemployment rate is around 5%.
• Unemployment rates are an estimate;
survey results are also imperfect because
of the underground economy such as tax
evaders and drug traffickers.
Inflation (cont.)
• Two competing ideas have developed
concerning inflation:
– The demand-pull theory
demand-pull inflation: theory that prices rise as the
result of excessive business and consumer demand;
demand increases faster than total supply, resulting in
shortages that lead to higher prices
• Fed allows the money supply to grow too rapidly
leading to higher demand and increased prices.
• Increases in government spending and
business investment can increase demand.
• Aggregate demand can increase if taxes are
reduced or consumers begin saving less.
Inflation
Inflation is caused by excessive
expansion of the money supply or
government spending, according to the
demand-pull theory.
• Like the unemployment rate, inflation can
be a major national problem.
Inflation (cont.)
– The cost-push theory
cost-push inflation: theory that
higher wages push up prices
• Unemployment can remain high during these
periods of cost-push inflation.
• According to some economists, stagflation
is a result of cost-push inflation.
stagflation: combination of inflation
and stagnation (low economic
activity)
Most economists subscribe to one of two
theories on the best way to stabilize the
economy.
The Circular Flow of Income and
Output
Keynesian economists advocate the
use of government spending to
stimulate economic activity and reduce
unemployment during recessions.
The Circular Flow of Income and
Output (cont.)
The Circular Flow of Income and
Output (cont.)
• John Maynard Keynes developed fiscal
policy theories during the Great Depression.
• The circular flow of income and output
is important to the Keynesian theory.
• He believed that government should step
in to stimulate aggregate demand during a
recession.
• Monies that are removed or outside the
circular flow of income, such as consumer
savings, are referred to as leakage.
fiscal policy: federal government’s
use of taxation and spending policies
to affect overall business activity
• Injections of income into the economy,
through business investment and
government spending offset leakages.
View: Circular Flow of Income and Output
Is government taxation a leakage or
injection?
A. Leakage
B. Injection
A. A
B. B
Fiscal Policy and Supply-Side
Effects
Supply-side economists advocate
reductions in tax rates to stimulate
private investment and employment.
Fiscal Policy and Supply-Side
Effects (cont.)
• Ways to fight unemployment and stimulate
the economy include:
– Job programs
– Cuts in federal taxes
– Giving businesses tax credits on
investments
Fiscal Policy and Supply-Side
Effects (cont.)
• Supply-side effects are the result of tax
cuts that lead to more work, savings and
investments.
time lags: periods between the time
fiscal policy is enacted and the time it
becomes effective
0%
B
A
0%
The Theory of Monetarism
Monetarists favor monetary policy
rather than fiscal policy to stabilize the
economy.
The Theory of Monetarism (cont.)
The Theory of Monetarism (cont.)
• Many economists who do not favor fiscal
policy as a way of stabilizing the economy
believe monetary policy is the answer.
• Monetarists believe that the Fed should
increase the money supply at a smooth,
given percent each year in order to avoid
inflation.
• Monetarists support the monetarism
theory.
• Monetarism is often linked with economist
Milton Friedman.
monetarism: theory that deals with the relationship
between the amount of money the Fed places in
circulation and the level of activity in the economy
Government Policy According to
Monetarists
Monetarists believe that the money
supply should be increased at a steady
rate of 3 to 5 percent each year for
stable economic growth with low
inflation.
Government Policy According to
Monetarists (cont.)
• Monetarists are opposed to using fiscal
policy to stimulate or slow the economy.
They believe:
– The government should balance the
federal budget.
– The Fed should follow a monetary rule at
a rate of 3 to 5 percent per year.
– Steady growth within strict guidelines is
best way to stabilize the future economy.
monetary rule: monetarists’ belief
that the Fed should allow the money
supply to grow at a smooth,
consistent rate per year and not use
monetary policy to stimulate or slow
the economy
Government Policy According to
Monetarists (cont.)
• Some countries use inflation targeting to
retain economic stability.
inflation targeting: a possible central
bank policy in which the head of the
central bank is given a specified
annual rate of inflation as a goal
View: Changing Fed Policies
Monetarists’ Criticism of Fiscal
Policy
Monetarists believe that the main
problem with fiscal policy is that it
cannot be implemented effectively.
Monetarists’ Criticism of Fiscal
Policy (cont.)
• Monetarists believe that the theory of fiscal
policy seldom matches reality for two main
reasons:
– No single government body designs and
implements fiscal policy.
– There are various time lags between
when it is enacted and when it becomes
effective.
View: Implementing Fiscal Policy