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5-14-12*********** New Test information
1. Short run gov’t policy
a. What should the gov’t do about a recession?
b. Why should they not do it?
i. In the context of the Phillips Curve
1. Looks at the connection between Inflation and unemployment
c. In the timeline of the 20th century
i. Theories
ii. Economy
iii. Policy
Short run Phillips Curve
Long run Phillips Curve
2. 1960 recession
a. 1961- Kennedy elected
i. Appointed 2 policy teams
1. Monetary team- Money (controlled by the fed)
2. Fiscal- Spending, Taxing, and deficits (controlled by congress)
ii. Used D.A.S.K. Policies
1. Discretionary- you get to choose
2. Activist- gonna actively manipulate the economy(laissez faire is do
nothing)
3. Stabilization- Attempt to make the economy stable
4. Keynesian- policy based on Keynesian theory(Above Phillips Curves)
iii. How to DASK
1. In a recession- need to increase Aggregate Demand (C,I,G or NX)
a. Fiscal- Spending: spend more, Taxing: tax less, By default deficit
will rise
b. Monetary- Inject money to increase inflation and bring down
unemployment (Keynes theory). This will lower interest rates
since people will save since prices don’t adjust immediately due
to stickiness. Lower interest rates will increase demand.
2. This begs the question- how much?
a. Just enough…
iv. Recommendations
1. Fiscal- Tax cut
2. Monetary- Inject lots of money.
a. The amount increased every year. By the time of the end of his
policy, inflation was near 7%
v. Due to these policies
1. Inflation rose
2. Unemployment fell. By 1969 got down to 3.4%
vi. Two conclusions
1. Keynes was right
2. DASK works
b. Why not DASK?
i. Because it’s DUM
1. Delays
a. There is a lag between when we enter a recession and our
policies take effect
i. Need to Recognize a problem, decide what to do,
implement changes, economy is slow to react
2. Unintended Consequences
a. General
i. Trying to fix something but you make it worse
ii. Fix something, but in that process you break something
else
b. Rules vs. Discretion
i. Non-economic policies
1. Discretion opens the door to manipulation
2. People don’t like to go without due to the rules
ii. Economic policy
1. Monetary- If the fed has discretion, they will try
to manipulate the economy to get lower
unemployment by having higher inflation
(misperception requires people to be surprised)
a. If people expect it, This locks us into
higher inflation without the lower
unemployment(inflation trap/
Inflationary bias)
b. Rules are required to prevent this
2. Fiscal policy
a. When given discretion
i. Politicians manipulate
voters(this brings “the political
business cycle”- the business
cycle that is booming around
elections)
ii. Special interest groups
manipulate politicians( this
brings “rent seeking”-seeking a
payback for campaign
contributions)
b. Rules prevent these
3. Mistakes
a. Theories
b. Policyi. not a dependable trade off between Unemployment
and Inflation
ii. Deficit spending- see below
c. Economy
3. 1970’s
a. Stagflation- High inflation and High unemployment
i. It contradicts Keynesian theory
b. The process of change to multiple Phillips Curves
i. Recession starts in 1969
ii. To try to control upward price/wage spirals, Nixon made it illegal to raise
anyone’s wages and prices. 1971-72
iii. Nixon removed in 1974. Johnson tried to stop inflation. WIN(whip inflation now)
iv. 4 Recessions in the 70’s finished the move
Multiple
Phillips
Curves
4. Deficit spending
a. Short runi. Stimulate demand
ii. Lower unemployment
b. Long run- Causes crowding out
i. Reduce supply of funds
ii. Raise interest rates
iii. Reduce demand
c. Deficit spending
i. Have to borrow $100 Billion
1. On one hand
a. Spending Increases AD
b. This will increase Income
i. This will increase Consumption
1. This increases Demand
a. The circle is complete and it
perpetuates itself
c. After several times around the money has multiplied up to $600
Billion
d. Theory only works in the short run when we are below full
employment
e. Same as trickle down economics
f. Proven to not work in the long run
2. On the other hand
a. Borrowing raises taxes
i. This raises AD
1. This causes crowding out