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American
Government and
Politics Today
Chapter 16
Economic Policy
Introduction
– A major economic policy issue is how to
maintain stable economic growth without
falling into either excessive unemployment or
inflation (rising prices).
– Inflation, a sustained rise in the general price
level of goods and services.
Good Times, Bad Times
– The U.S. economy experiences booms and busts. The busts are
called recessions.
• Recession, two or more successive quarters in which the
economy shrinks instead of grows.
– Unemployment
• Full employment, an arbitrary level of (around 5%)
unemployment that corresponds to “normal” friction in the
labor market.
• Measuring Unemployment. US Department of Labor
• Government Jobs Depression era Unemployment Insurance
– Inflation-A decline in the purchasing power of money over time
– The Business Cycle: reoccurring booms and busts
More than a Century of Unemployment
Changing Rates of Inflation: 1860-Present
National Business Activity, 1880-Present
Fiscal Policy
– Fiscal policy is concerned with achieving economic policy goals
through changes in spending or levels of taxation.
– Keynesian Economics
• Government Spending during slow times
• Government Borrowing over Government Taxes
– Government should spend more than it receives, runs a
deficit. Government makes up for both reduced
spending and borrowing by consumers
• Discretionary Fiscal Policy-left to the policy maker to finetune the economy
• Discretionary Fiscal Policy Failures-LBJ failure to tax during
a boom, borrowed instead and caused inflation. Nixon used
price controls causing inflation
– The Thorny Problem of Timing-Agenda building…take time
– Automatic Stabilizers-Tax system, unemployment insurance
Deficit Spending and the Public Debt
– The government funds its deficit primarily by selling U.S.
treasury bonds. Twenty years ago, only 15 percent of these
bonds were held abroad. Today the figure is 40 percent.
– The Public Debt in Perspective
• Net public debt, the accumulation of all past federal
government deficits; the total amount owed by the federal
government to individuals, businesses, and foreigners.
• Gross domestic product (GDP), the dollar value of all final
goods and services produced in a one-year period.
– Are We Always in Debt? Keynsian economics advocates
running budget surpluses during boom time. Clinton raised
taxes and together with the dot.com boom. He presided over a
budget surplus from 1998-2002. Then came 911.
Net Public Debt of the Federal Government
Net Public Debt as a Percentage of GDP
Monetary Policy
– Monetary policy, the utilization of changes in the amount of
money in circulation to alter credit markets, employment, and
the rate of inflation.
– Organization of the Federal Reserve System
• 7 full-time members appointed by the president. Operate 12
banks with 25 branches to hold reserves. Federal open
market Committee makes monetary policy decisions largely
independently
– Loose and Tight Monetary Policies. The Fed implements policy
by increasing or reducing the rate of growth of the money
supply. The cost of borrowing money.
• Increasing the rate of growth is loose monetary policy. Cheap
money. Fast economy.
• Reducing the rate is tight monetary policy. Expensive money.
Slow economy.
Monetary Policy (cont.)
–Monetary policy has a problem with time lags, but the Fed
can make a policy change more quickly than Congress.
–The Fed announces changes to monetary policy by raising
or lowering the federal funds rate, a government-controlled
interest rate for funds that banks borrow from each other.
–The Fed Tackles Inflation
• Volkernomics
–Monetary Policy versus Fiscal Policy. If interest rates go
high enough, people will stop borrowing and inflation will
subside. Monetary policy cannot force people to borrow
money in a recession. While monetary policy is more
powerful against inflation, fiscal policy is more effective
against recessions, because the government does the
borrowing itself.
World Trade
–Imports and Exports
• Imports, goods and services produced outside a
country but sold within its borders.
• Exports, goods and services produced
domestically for sale abroad.
–The Impact of Import Restrictions on Exports
• Protecting American Jobs
• Quotas and Tariffs
• Free Trade Areas and Common Markets
World Trade Keeps Growing
The World Trade Organization
– The WTO seeks to lower trade barriers
worldwide.
•What the WTO Does: The WTO also has
a dispute-resolution mechanism that
nations may use.
– The WTO and Globalization.
•The WTO has become the focus of those
who fear the supposed dangers of
globalization. It is true that neither the
United States nor any other country has
a veto power within the WTO.
The Balance of Trade and the
Current Account Balance
– The balance of trade, or the difference between
the value of a nation’s exports of goods and
its imports of goods. The U.S. balance of
trade has been significantly negative for
many years.
– The current account balance includes the
balance of trade in services, unilateral
transfers, and other items. It is also negative
and has been growing more so.
– Are we borrowing too much from other
countries?
The Current Account Deficit
Taxes as a Percentage of GDP in Major
Industrialized Nations
The Politics of Taxes
– Currently, Americans pay taxes that total to
somewhat less than 30 percent of the GDP.
– Federal Income Tax Rates
• Loopholes and Lowered Taxes
• Progressive and Regressive Taxation
– Who Pays?
• Liberals tend to favor progressive taxes.
• Conservatives either favor taxes that are less
progressive, or even flat or regressive.