Download Economic Policy

Economic Policy
Chapter 19
Pearson-Longman copyright 2005
Economic Growth and the
Business Cycle
• Economies grow as the result of
technological innovation, investments
in physical capital and human capital.
• Gross Domestic Product (GDP)
– The measure of the total value of
economic activity in a nation in one
year.
Pearson-Longman copyright 2005
Pearson-Longman copyright 2005
Economic Growth and the
Business Cycle
• Recession
– A slowdown in economic activity, officially defined as
a decline that persists for two quarters (six months).
• Business Cycle
– The alternation of periods of economic growth with
periods of economic slowdown.
• Governments try to set economic policies that
minimize disruptions caused by the business
cycle. Avoid inflation and unemployment.
Pearson-Longman copyright 2005
Economic Growth and the
Business Cycle
• Inflation
– A sustained rise in the price level such that
people need more money to purchase the same
amount of goods and services.
• Unemployment
– The circumstance that exists when people who
are willing to work at the prevailing wage
cannot get jobs.
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Economic Conditions and
Political Fortunes
• People tend to blame those
in charge when times are
hard.
• Often presidents will lose
popularity when the
economy falters.
• Very bad economic times
are associated with
massive election losses for
the party of the president.
• Prosperity strengthens a
president’s position in a
reelection campaign and
may help in congressional
elections as well.
Pearson-Longman copyright 2005
Pearson-Longman copyright 2005
Fiscal Policy
• Fiscal policy: The sum total of government
taxing and spending decisions, which
determines the level of the deficit or
surplus.
– Deficit: The amount by which annual spending
exceeds revenue.
– Surplus: The amount by which annual revenue
exceeds spending.
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Use of the Budget Deficit
• Keynesianism
– Economic policy based on the belief that
governments can control the economy by
manipulating demand, running deficits to
expand it, and surpluses to contract it.
– F.D.R. broke with traditional belief in a
balanced budget and ran large deficits during
the 1930s to get the country moving again.
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Use of the Budget Deficit
• Council of Economic Advisors (CEA)
– Three economists who head up a professional staff that
advises the president on economic policy.
– Established in 1946 by Congress
– CEA declined in importance in 1980s and 90s
– Presidents relied more on White House staffers,
treasury secretaries, and other political aides.
– G.W. Bush has utilized the CEA.
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Decline of Fiscal Policy
• Administrators less likely to use fiscal
policy as a tool for managing the economy
today.
• Why?
–
–
–
–
Divided government
Monetarism
Budget deficits
Internationalization
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Monetary Policy: The Federal
Reserve System
• Monetary Policy
– The actions taken by government to vary the supply of money in
an effort to stabilize the business cycle.
– When supply of money increased, it is cheaper for private citizens
and investors to borrow and spend more of it.
• Ex: interest rates decline and more economic growth
• If supply increases too quickly = inflation.
– If money supply is down, borrowing is more costly. Less to spend
and invest so the economy slows.
• If supply less inflation will decrease, but if the economy contracts too
quickly, result is likely to be unemployment.
Pearson-Longman copyright 2005
Pearson-Longman copyright 2005
Monetary Policy: The Federal
Reserve System
• Federal Reserve System
– The country’s central bank, which executes monetary policy by
manipulating the supply of funds that member banks can lend.
– Acts on the economy through the operations of its 12 regional
banks.
– Open Market Committee
• considers whether interest rates are too high or two low and what
adjustments should be made.
• Three primary tools: buy and sell federal securities, change the
interest rate, change the percentage of deposits that banks are required
to hold in reserve.
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The Fed Chair
• The Fed is the second most powerful agency in
Washington, D.C.
• Chair of the Federal Reserve Board ranks among
the most powerful persons in government.
– Close ties to the president
– direct access to economic information
– power to approve appointments of Fed Reserve Bank
chairs
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Who Controls the Fed?
• Relatively insulated from electoral pressure.
• Congress has some influence.
– Created by congressional statutes.
– Nominees to Fed Reserve Board must be approved by
the Senate.
– Must make quarterly reports to banking committees in
House and Senate.
– BUT, The Fed’s budget is not congressionally
determined.
• Fed raises its own revenue. Hires its own staff.
Pearson-Longman copyright 2005
Who Controls the Fed?
• Other influences include:
– Banker dominance
– Presidential dominance
• Generally thought to be very independent.
–
–
–
–
–
Guaranteed by 14 year terms for board members.
Only removed through impeachment process.
Chair serves a 4 year term.
More expert than political appointee.
Generates confidence from business.
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The “T” Word: Taxes
• Taxes are a much-debated topic in American
politics.
• Debates centers on three important issues:
– tax burden
– the breadth of the tax base
– progressivity of the tax structure
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Pearson-Longman copyright 2005
The Tax Burden
• Tax burden: The total amount of tax that a
household pays.
• Federal individual income tax receipts (as % of
GDP) rose by over 60% from 1950 to 1970).
• As long as living standards on rise, people willing
to absorb higher taxes.
• Sizable budget surplus in late 1990s encouraged
proposals for tax reductions.
• G.W. Bush - extensive tax cuts.
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The Tax Base
• Tax Base
– Types of activities, types of property, or kinds of
investments that are subject to taxation.
• Some argue more broad-based taxes are less
intrusive.
• Tax Preferences
– Special tax treatment received by certain activities,
property, or investments.
– Ex: tax credit for college tuition.
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The Tax Base
• Tax preferences = classic slippery slope.
– Once government grants them to one group, it abandons
the principle of neutral taxation.
– Granting preferences to some means that others must
make up the shortfall.
– Sin taxes - when special tax treatment is unfavorable.
• A tax intended to discourage unwanted behavior.
• Cigarettes and alcohol.
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Tax Progressivity
• Progressive Tax
– A tax structured so that higher-income people pay a
larger proportion of their income in taxes than do
lower-income people.
– Ex: income tax
• Regressive Tax
– A tax structured so that higher income people pay a
smaller proportion of their income in taxes than do
lower-income people.
– Ex: payroll or social security tax
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Tax Reform
• Flat tax
– A tax that is neither progressive nor regressive;
everyone pays at the same rate.
– Advocates of the flat tax argue that it is unfair
to require some people to pay a higher
percentage of their income in taxes than others.
– More efficient; closes loopholes and need for
professionals who work in tax preparation.
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The U.S. Economy: An
International Comparison
• When the Fed loosens or tightens the money
supply, it is reacting to national and global
economic forces.
• Sometimes, regardless of effort, it may be
overcome.
• But where do we stand overall compared to
other advanced democracies?
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Taxes
• Tax burden in U.S. compares favorably with that
in the world’s other developed countries.
• Among the lowest of the 13 major industrialized
countries.
• Roughly 32% of GDP
• Other countries pay more but provide more
services.
• We rely more on income and payroll taxes. Other
countries rely more heavily on consumption taxes.
Pearson-Longman copyright 2005
Pearson-Longman copyright 2005
National Debt
• In 2004 the national debt was 7.5 trillion
dollars.
• Size of the American economy at that time:
11 trillion dollars.
• Our debt considered moderate.
• As a proportion of GDP, France, Germany,
and Canada all have national debts that are
larger.
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Pearson-Longman copyright 2005
Employment Opportunities
• The United States has done a better job than most countries
of incorporating new workers into the economy.
• Unemployment rate in 2003 for western Europe: 9
percent. U.S.: 5.9 percent.
• Some European countries required “guest workers” to
return to their country of origin.
• U.S. allowed immigration to increase in the 1980s.
• “McJobs” or good jobs? Evidence suggests they are higher
paying occupations.
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Inequality
• Price of limited government seems to be
greater social inequality.
• Compared to other advanced democracies,
income inequality is the U.S. is higher.
• Emergent “class war”?
• But where is the popular demand to
intervene?
Pearson-Longman copyright 2005
Pearson-Longman copyright 2005