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Transcript
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