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ECONOMIC POLICY Chapter 18 O’Connor and Sabato American Government: Continuity and Change Industrialization • Following the Civil War, the US moved from an agrarian to a manufacturing based economy as the US industrialized many large-scale factories were created. • This shift lead to many national economic problems. Industrialization National problems such as… – fluctuations between periods of economic prosperity and economic downturn – Industrial accidents – Disease outbreaks – Labor conflict – Unemployment and the exploitation of workers were too large and complex for state governments alone. Laissez-Faire Doctrine • A French term meaning “to allow to do, to leave alone.” • It is a hands-off governmental policy that is based on the belief that governmental regulation of the economy is wrong. • Essentially, what businesses thought of as laissez-faire was an economic system and a set of governmental policies that would be supportive of the amassing of profits. Economic Policy – Mr. Ruelas • No Bell Ringer • #5 in TOC – Economic Policy Adam Smith’s Wealth of Nations • The role of government should be limited to the maintenance of order and justice, the conducts of foreign affairs, and the provision of necessary public works projects. • Individuals should be left free to pursue their selfinterests. • Competition and the laws of supply and demand would control their behavior and ensure that selfinterests did not get out of hand. (um. no.) Congressional Acts • To control banking and regulate business, Congress passed three acts: • 1.The Federal Reserve Act (1913) created the Federal Reserve System: The FRS regulates the national banking system and to provide flexibility in the money supply.( more on this to follow) • 2. Establishment of the Federal Trade Commission (FTC): a bipartisan body of five members appointed by the President for seven year terms. This commission was authorized to issue Cease and Desist (an order or request to halt an activity (cease) and not to take it up again later (desist); or else face legal action. The recipient of the cease-and-desist may be an individual or an organization. • 3.The Clayton Act (1914) prohibited unfair business practices such as price discrimination, exclusive dealing contracts, and corporate mergers that lessen competition. The Great Depression / New Deal • The Great Depression (a catastrophic worldwide economic downturn) began with – – – – – a stock market collapse followed by rising unemployment dropping prices falling production and financial panic. • President Hoover announced that there was nothing wrong and the economy was fundamentally sound. Panic ensued. • FDR called for and Congress enacted a "New Deal" for Americans. This legislation allowed for strong government participation in the economy to relieve the nation’s economic distress. Financial Reforms of the New Deal • Glass-Steagall Act (1933): required the separation of commercial and investment banking and set up the Federal Deposit Insurance Corporation (FDIC). • Securities Act (1933): required that investors be given full and accurate information about stocks and securities being offered to them • Securities Exchange Act (1934): created the Securities Exchange Commission (SEC) which regulated the stock exchange, enforced the Securities Act, and reduce the number of stocks bought on margin. • Buying on margin: to borrow money to purchase stocks Labor Reforms • National Labor Relations Act of 1935 (Wagner Act) – Guaranteed worker’s rights to organize and bargain collectively through unions of their own choosing • National Labor Relations Board – Created to carry out the act and to conduct elections to determine which union, if any, employees wanted to represent them. • Fair Labor Standards Act (1938) – Intended to protect the interests of low-paid workers, the law set 25 cents per hour and 44 hours per week as initial minimum standards. Legacy of the New Deal Era • Passive government was replaced by active government. • The Federal government became the primary source of solutions for economic problems. • People look to the government to establish fiscal and monetary policies that keep the economy moving forward. Today’s Minimum Wage • What is CA's minimum wage? The California minimum wage of $9.00 per hour is the lowest amount a non-exempt employee in California can legally be paid for hourly work. • How much does a minimum wage worker in California earn per year? A full time minimum wage worker in California working 40 hours a week, 52 weeks a year, will earn $360.00 per week, or $18,720.00 per year1. • This does not include federal state taxes • The national poverty line for a family unit consisting of two people is $16,570/year. • The price of a gallon of gasoline is about half the hourly minimum wage. • https://www.youtube.com/watch?v=slFZ8K2aBoY What is Economics? • What Does Macroeconomics Mean? Macroeconomics examines economy-wide phenomena such as changes in unemployment, national income, rate of growth, gross domestic product, inflation and price levels. • What Does Microeconomics mean? The branch of economics that analyzes the market behavior of individual consumers and firms in an attempt to understand the decision-making process of firms and households. It is concerned with the interaction between individual buyers and sellers and the factors that influence the choices made by buyers and sellers. • In particular, microeconomics focuses on patterns of supply and demand and the determination of price and output in individual markets (e.g. coffee industry). Economic Terms to Know • Economic stability: a situation in which there is economic growth, rising national income, high employment, and steadiness in the general level of prices • Inflation: A rise in the general price levels of an economy. Your money is worth less because a dollar buys you less. • Recession: A decline in the economy that occurs as investment sags, production is decreased, and unemployment increases. • Monetary Policy: government policies and practices that control the nation’s money supply and interest rates to maintain the economy. • Fiscal Policy: government policies and practices on taxes, spending, debt management that influence the economy How Does the Government Control the Economy? • The US government primarily uses two instruments to affect the economy… – Monetary policy – Fiscal policy Basic Premise of Monetary Policy • Monetary policy is the way the Federal Reserve controls the money supply via interest rates. • The lower the interest rates the more people will borrow. • The more people borrow the more they will spend. • The more people spend the stronger the economic growth. • The opposite is also true. Monetary Policy • Monetary policy involves the regulation of the country's money supply and interest rates. • The primary responsibility for monetary policy rests with the Federal Reserve Board (Feds). • The Federal Reserve System was created in 1913 consists of: – Federal Reserve Board: a seven-member board that sets member banks’ reserve requirements, controls the discount rate, and controls credit available – the Federal Open Market Committee – 12 Federal Reserve Banks The Federal Reserve System • The Fed regulates and manages the money supply in accordance with the levels of output, employment, and prices. • The Fed has three tools at its disposal: 1. Open Market Operations 2. Reserve Ratio 3. Discount Rate 1. Open Market Operations • The Fed buys and sells government securities (stocks and bonds) to commercial banks and to the general public. • The buying of bonds increases the money supply by putting dollars into circulation. • The selling of bonds decreases the money supply by removing dollars from circulation. • This is the primary tool used by the Fed to alter and regulate the money supply. What are Bonds? • Companies and governments issue bonds to fund their dayto-day operations or to finance specific projects. When you buy a bond, you are loaning your money for a certain period of time to the issuer, be it General Electric or Uncle Sam. • In exchange, the borrower promises to pay you interest every year and to return your principal at "maturity," when the loan comes due, or at "call" if the bond is of the type that can be called earlier than its maturity (more on this later). The length of time to maturity is called the "term." 2. Reserve Ratio • This is the mandated percentage of deposits that banks are required to keep. • If the Fed increases the reserve ratio, it reduces the money supply by increasing the amount of cash that a bank has to keep in its vault ( required reserves). • By increasing the required reserves for banks, the Fed decreases the amount of the bank’s excess reserves and, hence, the amount of money that banks have to loan. • If the Fed reduces the reserve ratio, it increases the money supply by decreasing the amount of required reserves and, hence, increasing the amount of excess reserves and loanable funds. 3. Discount Rate • This is the interest rate that the Fed charges on money loaned to commercial banks. • Many short-term interest rates are tied to the discount rate. • If the Fed increases the discount rate, it decreases the money supply by decreasing borrowing (increases interest rates). • If the Fed decreases the discount rate, it increases the money supply by stimulating borrowing (decreased interest rates). • Altering the discount rate is often used to send a signal to financial markets as to the type of monetary policy the fed is undertaking. Expansionary Monetary Policy • Policies to increase the money supply are used when growth in the economy is too slow or stagnant. Specifically, the economy is faced with high unemployment and deflation. • To increase the money supply the Fed would: Buy securities Reduce the reserve ratio Lower the discount rate • This would stimulate investment which leads to firm production and employment. Contractionary Monetary Policy • Policies to decrease the money supply are used when growth in the economy is too fast. That is, the economy is faced with cost-push inflation created by labor shortages. • Cost-push inflation is when a shortage of supply of labor, raw materials or capital drives up prices. The demand remains the same, but since there are fewer goods or services, the supplier can charge more per unit. • To decrease the money supply the Fed would; Sell securities Increase the reserve ratio Raise the discount rate • This is used to decrease investment and slow economic expansion. The Federal Reserve Districts The Federal Reserve System • The Federal Reserve is the central bank of the United States. • Its unique structure includes a federal government agency, the Board of Governors, in Washington, D.C., and • 12 regional Reserve Banks operating 25 branches. • http://youtu.be/y1OJlJ9COg0 Chairperson Janet Yellen • Janet Yellen began her term on February 1, 2014. • She is the first woman to hold this position. • There have only been 15 Chairpersons of the Federal Reserve Board. • The Chair is the "active executive officer"[2] of the Board of Governors of the Federal Reserve System Retail Banks • A retail bank is a bank that works with consumers, otherwise known as 'retail customers'. Retail banks provide basic banking services to the general public, including: • Checking and savings accounts • CDs • Safe deposit boxes • Mortgages and second mortgages • Auto loans • Unsecured and revolving loans such as credit cards Commercial Banks • A commercial bank is a bank that works with businesses. Commercial banks handle banking needs for large and small businesses, including: • Basic accounts such as savings and checking • Lending money for real and capital purchases • Lines of credit • Letters of credit • Lockbox services • Payment and transaction processing (settlement) Investment Banks • Investment banks help organizations use investment markets. For example, when a company wants to raise money by issuing stocks or bonds, an investment bank helps them through the process. • Investment banks also consult on mergers and acquisitions, among other things. • Investment banks primarily work in the investment markets and do not take customer deposits. However, some large investment banks also serve as commercial banks or retail banks. The Stock Market • Basically the stock market is a place where you can buy and sell shares in a company. • When a company makes shares available for the public to buy they are called stocks and this is what you are trading. • In most cases what you get when you buy a stock is a very small piece of the company. You are an owner of that company and as it grows the company should become more valuable which means that your stocks should become more valuable as well. • Since the goal of investors is to get the maximum return on their investment the goal is to buy the stock before the price goes up and then to sell it before it goes back down. • This means that you have to pay attention to what the value of the company you are buying stock in will be in the future. Stock Market Continued • This is why you often see the price of the stock go up before an earnings announcement and then decline even if the earnings were higher than expected. People bought the stock in the expectation of good earnings which drove the price up and then sold when the good earnings were announced since it was likely that the stocks value had peaked, at least temporarily. • One thing that confuses a lot of people when the invest in the stock market is that they don't receive any of the company's profits. In a few cases you will, mainly with large well established companies, this is called the dividend which is paid on a per share basis. • However with most companies they will retain the profits to help pay for future growth. Most investors are more interested in growth than in receiving dividends. • There is a school of thought that you should invest in companies that pay dividends. • http://youtu.be/ejjNMnIo3Fg Futures Contracts • A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a predetermined price in the future. • This is done to avoid price volatility. • Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. • This transfers the risks and rewards to the investor. • Some futures contracts may call for physical delivery of the asset, while others are settled in cash • http://www.investopedia.com/video/play/futures-contractexplained Securities • A document; historically, a physical certificate but increasingly electronic, showing that one owns a portion of a publicly-traded company or is owed a portion of a debt issue. • Securities are tradable in the securities market. • At their most basic, securities refer to stocks and bonds, but the term sometimes also refers to derivatives such as futures and options. • Government securities include Treasury Bonds and Bills. • All government securities are regulated by FINRA ( Financial Industry Regulatory Authority) • http://youtu.be/MfvCXmUsOa8 Derivatives • A derivative is a financial instrument that gets its value from an authentic good or stock. • It is, in its most basic form, simply a contract between two parties to exchange value based on the action of a real good or service. • Typically, the seller receives money in exchange for an agreement to purchase or sell some good or service at some specified future date. • http://youtu.be/m3im-iJdhv4 • Show Clip from Capitalism: A Love Story Mutual Funds • A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a mutual fund as a company that brings together a group of people and invests their money in stocks, bonds, and other securities. • Each investor owns shares, which represent a portion of the holdings of the fund. You can make money from a mutual fund in three ways: 1) Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. 2) If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution. 3) If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit. • http://youtu.be/TPS22HRRY1k Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares. The President and the Federal Reserve Board • Although the public holds the president responsible for maintaining a healthy economy, he does not possess adequate constitutional or legal authority to do this. • The President shares this responsibility with Congress. • Congress authorizes the FRB to make monetary policy. • At best, the President has the “power to persuade” the FRB to adjust monetary policy (adjust interest rate) • During formal meetings, the chairperson of the FRB conveys his views on the economy to the administration. • The president customarily accepts the monetary policy made by the FRB. th 16 Amendment • The Sixteenth Amendment (Amendment XVI) to the United States Constitution allows the Congress to levy an income tax without apportioning it among the states or basing it on Census results. • Income tax is how the government funds programs and services. Taxation • Progressive tax (aka graduated income tax): tax in which the average tax rate increases as the amount subject to taxation increases. • Regressive tax: a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases • Flat tax: a system of taxation where one tax rate is applied to all income with no deductions or exemptions. • A proportional tax is a tax imposed so that the tax rate is fixed. The amount of the tax is in proportion to the amount subject to taxation • The taxation of people is part of fiscal policy. • Ways and Means Committee initiates tax policy. Fiscal Policy • Fiscal Policy is defined as: the deliberate use of the national government’s taxing and spending policies to influence the overall operation of the economy and maintain economic stability. • Intention of Fiscal Policy: promote the nation’s macroeconomic goals, particularly with respect to employment, price stability, and growth. • The President and Congress formulate fiscal policy and conduct it through the federal budget process. • We just saw how the President and Congress struggle to agree on the federal budget. (power of the purse) • Tax policy is done by the Ways and Means Committee. Fiscal Policy • Following the economist John Maynard Keynes, government spending has been used to offset a decline in private spending and help maintain – – – – levels of spending production employment. Argued that deficit spending by a government could supplement the total demand for good and services. • Fiscal policy involves taxation and government spending policies to influence the overall operation of the economy. Deficit Spending • Deficit spending is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit," the opposite of budget surplus. • Many economists argue over the issue of deficit spending and whether it is sound economic practice. Deficit Controversy • Mainstream economists feel that deficit spending is desirable and necessary as a part of fiscal policy. • In an economic slump (recession), government should run deficits to compensate for the shortfall in aggregate demand, but should run corresponding surpluses in boom times so that there is no net deficit over an economic cycle – a cyclical deficit. • Aggregate demand is the total demand for final goods and services in the economy (Y) at a given time and price level. • This is derived from Keynesian economics . • Fiscal conservatives reject Keynesianism and, in the strongest form, argue that government should always run a balanced budget (and a surplus to pay down any outstanding debt), and that deficit spending is always bad policy. Other Arguments Against Deficits • The usual argument against deficit spending is that households should not run deficits – one should have money before one spends it, from prudence – and that what is correct for a household is correct for a nation and its government. • A further argument is that debts must be repaid, and thus it is burdening future generations to run deficits today, for little or no gain. Deficit vs. Debt • Suppose you spend more money this month than your income. This situation is called a "budget deficit". So you borrow (ie; use your credit card). • The amount you borrowed (and now owe) is called your debt. You have to pay interest on your debt. • If next month you spend more than your income, another deficit, you must borrow some more, and you'll still have to pay the interest on your debt (now larger). • If you have a deficit every month, you keep borrowing and your debt grows. • Soon the interest payment on your loan is bigger than any other item in your budget. • Eventually, all you can do is pay the interest payment, and you don't have any money left over for anything else. This situation is known as bankruptcy. • Debt= Accumulative Deficits Google drive: Deficit and Debt Video Congress and the Budget • Budget and Accounting Act of 1921 – Gave the president authority to prepare an annual budget and submit it to Congress • Staff agency now called the Office of Management and Budget was created to assist the president in this process. • President sends budget proposal to Congress in January or February of each year. • Congress and the appropriations committees actually provide the funding needed to carry out programs (power of the purse). The Budget Process • POTUS writes the budget with the help of the Office of Management and Budget (OMB) by the first Monday of February. • The budget is sent to Congress for approval. • Congress utilized the services of the Congressional Budget Office (CBO) to give recommendations and/or concerns. • POTUS either approves the recommendation or alters and resubmits the budget to Congress. • Executive version and Legislative version must be the same. This is due by April 15th. • The fiscal year begins October 1st and ends last day of September. • http://youtu.be/EhUTz4KUl8M • https://youtu.be/fWu8o-ZzUNs Budget and Impound Control Act of 1974 • Congress established this act to give itself more control over the budget process. • The process includes: • setting overall levels of revenues and expenditures • Size of the budget surplus or deficit (debt ceiling) • Prioritizing among different functional areas including defense, foreign aid, transportation, etc. The Federal Budget Process Purpose of the Budget • Purpose: fund government programs and services. • The federal budget planning begins roughly one and a half years before the fiscal year it is to take affect. • Once a budget is adopted, it takes time to implement the provisions. • The budget is not a precise instrument for manipulating the economy. • The process is complex, disjointed, and political. Raising and Spending Money • The federal government raises the most money from individual income taxes and social insurance and retirement receipts (this includes Social security, hospital insurance, and other taxes). • Most government spending is directed towards National Defense and Human Resources. • Human resources includes health, income security, and social security. Deficit and the Budget • Show the clips from AP Institute google docs. Deficit and the Budget Showdown on the Budget U.S. Debt Crisis • US Budget a visual perspective https://youtu.be/R6GtsXv0VtY TAXES and SPENDING Income Security Programs • ISP’s protect people against loss of income due to retirement, disability, unemployment, death, or absence of the family breadwinner. • ISP’s have two categories: non-means based and means-tested. • Non-means: provide cash assistance to qualified beneficiaries. • Means-tested: people must have incomes below specified levels to be eligible for benefits. Social Insurance Programs The Effectiveness of Income Security Programs • Entitlement programs – Income security programs to which all those meeting eligibility criteria are entitled. – Spending for such programs is mandatory. • Funds must be provided for them unless laws creating the programs are changed. • Difficult to control spending for this reason. • Often a matter of considerable debate. • Range of such programs are characteristic of all democratic industrial societies. Entitlement Programs • Income security program to which all those meeting eligibility requirements are entitled. • Examples include social security, food stamps, unemployment benefits, school breakfast or lunch program, and Woman Infant Children coupons (WIC). • Spending for entitlement programs is mandatory More Examples of Entitlement • The most important examples of entitlement programs at the federal level in the United States would include Social Security, Medicare, and Medicaid, most Veterans' Administration programs, federal employee and military retirement plans, unemployment compensation, food stamps, and agricultural price support programs. Discretionary Spending • Discretionary spending is a spending category through which governments can spend through an appropriations act. • This spending is optional as part of fiscal policy, in contrast to entitlement programs for which funding is mandatory. • Discretionary spending can be increased or decreased as part of the annual budget approval process. Automatic Stabilizers • Designed to operate without decisions by policymakers • Act as buffers when the economy weakens by automatically reducing taxes and increasing government spending • When the economy declines, mandatory spending for such programs as unemployment insurance, food stamps, and Medicaid INCREASES because eligibility benefits depends on people’s income or unemployment status. • In a slower economy, since people and corporations have less money, tax payments fall and help reduce the decline in after-tax incomes. • Although automatic stabilizers are helpful in mitigating economic fluctuations, they are by themselves inadequate to stabilize, control, and maintain the economy. Entitlements and Discretionary Spending 1963-2007 Gross Domestic Product • The GDP is the total market value of all goods and services produced in a country during a year. • Budget deficit: The amount by which a government’s spending exceeds its income over a particular period of time. (aka deficit spending) • Budget deficits are expressed as a percentage of the GDP. • Yearly deficits increased national debt. • During the 1980’s the national debt tripled from $909 billion to over $2.87 trillion in 1989. • By 1996 the national debt was nearly $5 trillion. • The national debt increases an average of $4.09 billion per day! • The current national debt (May 2014) is over $17 trillion. Yikes • http://www.brillig.com/debt_clock/ Causes of Rising National Debt • • • • • • • • • Post 9/11 policies and programs Multiple Wars and military conflicts Increase in military spending Government bailouts to corporations Inadequate corporate taxation policies Tax exemptions for the wealthiest Federal loan assistance programs Growth in Human Resource Spending Federal spending in recovery and assistance in national and international natural disasters.