Download Monetary Policy & Fiscal Policy

Monetary Policy & Fiscal Policy
Putting Oomph in the
C and I of the GDP
Monetary Policy 
What the Federal
Reserve can do to “fix”
the economy.
–


Consumption and
Investment
Works to keep monetary
inflation under control
Fight demand – pull
inflation with controlling
the interest rates.
The Goals of the Federal Reserve



Regulating the money supply
Serving as the government’s bank
Supervising FDIC banks.
–
–
Clearing checks
loans
The Money Supply: Types of Money
M1: Money that is readily
made into cash or is
cash.
M2: M1 + savings CDs,
money markets, savings
deposits.
M3 and L: M1 + M2 +
large CDs, stort term
treasury bonds and other
“near money.”
100
50
0
Monetary Policy and Aggregate
Demand
Easy Money Policy
Low interest rates,
makes money cheap.
Increases C and I.
Tight Money Policy
Higher interest rates
makes money
expensive.
Decreases C and I.
Ben Bernanke’s Economic Tools




Open Market
Operations.
Discount Rate
Prime rate
Reserve Requirements
Open Market Operations

If Bernanke wants to get more money into the
economy he BUYS government bonds from
banks.
–
–
Banks have more money to loan to customers.
People then have more money to consume and
invest.
Discount Rate

The interest rate that the Fed charges to
banks.
–
The Fed raises the discount rate. The banks pass
the increase on to customers.

Money is more expensive for customers as interest rates
go up. THE PRIME RATE.
Main Types of Interest Rates in
2009

Discount Rate
–
How much it costs to get
money from the Fed



Fed Funds Rate
–
How much money it costs to
get money from other banks.



.5% (2009)
2.25% (2008)
.25% (2009)
2% (2008)
Prime Rate
–
Best rate for best customers.


3.25% (2009)
5.0% (2008)
Reserve Requirement

Money that must be held by banks in their
vaults or at the Fed.
-Raise the reserve requirements on a bank. They
have LESS money to loan to customers.
Less money is available – it makes the price of
money (the interest rate) go up. SCARCITY.
Makes C and I go down.
-BUT THESE RESERVES ARE WHAT IS MEANT
TO BACK UP FAILED BANKS!
Federal Reserve Problems?



Economic forecasting
might not be quite
correct.
Ben Bernanke’s priorities
might not be the publics.
Lack of coordination with
fiscal policies.
Special Issues for banks in 2009




New powers for the Fed
Chair
Stress Tests
Bank Failures
Getting credit going in
the marketplace again.
Did Bernanke realize things could
go wrong in February 2008?

February – July 2008,
the federal government
granted Chairman
Bernanke “extraordinary”
powers that had once
been Congress’ domain
in the economy.
Bernanke’s new powers

The Federal Reserve should
have a much larger role in
supervising investment banks
to prevent and limit financial
market turmoil, Federal
Reserve Chairman Ben
Bernanke said, endorsing an
expansion of the central
bank's authority into new
territory.
Bernanke’s Argument for the Fed
Powers


"Holding the Fed more
formally accountable for
promoting financial stability
makes sense only if the
institution's powers are
consistent with its
responsibilities," Bernanke
said.
Congress should consider
giving the Fed power to set
standards for capital liquidity
holdings and risk
management for investment
banks, as it now does for
commercial banks
October 2008

Bernanke talked to the
President and
Congressional
leadership in a 45
minute private meeting.
October 2008 - Present

Chairman Bernanke and
Secretary of the
Treasury Geitner have
extraordinary powers to
intervene in the
economy.
–
–
–
Stimulus money injections
Regulation of banks /
corporations
Controlling of
corporations?
Stress Tests

Banks would have to assume
that the economy contracts by
3.3 percent this year and
remains almost flat in 2010.
They would also have to
assume that housing prices
fall another 22 percent this
year and that unemployment
would shoot to 8.9 percent
this year and hit 10.3 percent
in 2010.
–
DO THEY HAVE THE
RESERVES TO SURVIVE?
Stress Tests


The average outlook of
private-sector forecasters
envisions the economy
shrinking by 2 percent this
year and unemployment
peaking just below 9 percent
in 2010.
The average forecast for
housing prices is a decline of
14 percent this year and an
additional 4 percent next year.
Economic Forecasting by the Fed?

Recent forecasts by the
Federal Reserve and
most private forecasters
have undershot the
severity of the downturn.
Bank Failures



29 so far in 2009!
57 failures (1998 – 2008)
DOES THE FED HAVE
ENOUGH MONEY?
Fiscal Policy and the Economy

How does the President and Congress affect
the economy?
–
Control of tax rate.



Proportional taxes (flat tax) – say 5% of everyone’s income
whether you or Bill Gates.
Progressive taxes – Richer should pay more. Luxury taxes.
Regressive taxes – Taxes the poor tend to pay more.
Lottery tickets, cigarette taxes.
Taxes

Majority of revenue for
the US is through
income tax. 45.2%
–
–
Second is Social security
taxes and contributions.
35%
Third is corporate taxes.
11%
Recession



People have the money
but don’t spend it.
Unemployment goes up.
GDP slows.
Fiscal Cures for Recession

Change the tax rates.
–
Puts more money in the economy for Consumption
and Investment.
–
Government Spending. Unemployment benefits,
money for projects like roads, building
improvements.
Problems of Fiscal Policies




Timing Problems. Might
trigger inflation.
Political Pressures.
Lack of coordination.
Unpredictable economic
behaviors.
–
What worked in the past
might not work now.
Problem of Fiscal Policy in 2009:
The Deficit


When government
SPENDS (outlays) more
than they TAKE IN
(receipts) in taxes for the
year – DEFICIT.
Projected 2009 deficit is
-$490 Billion to 1.8
TRILLION.
Debt v. Deficit


In 2009 the government will spend somewhere
between 490 billion to 1.8 trillion more than it
takes in revenue. (DEFICIT)
US Debt is at http://www.brillig.com/debt_clock/
–
Or google US debt clock.
What is causing the deficit?

Higher government
expenditures
–
–
–
War in Iraq / Afghanistan
Government needs
Lack of taxes being
collected due to


Recession
Too many tax cuts in the
early 2000’s
Governments typically engage in
deficit spending

Developed by economist
John Maynard Keynes
(1883 – 1946) to help
get government out of
the Great Depression
(1930s)
Keynsian Economics


Fiscal Policy where it is
more important to get
the people of the country
working.
Government goes into
debt to employ people or
give them benefits until
they can find a job.
Keynsian Economics


IMPORTANT POINT!!!
Okay to go into debt when
times are bad.
–
–
–
People are employed, they
begin to consume and invest
again.
Then government can collect
taxes.
WHEN TIMES ARE “GOOD”
UP THE TAXES TO GET
READY FOR THE NEXT
“BAD” TIME.
US Government has not
remembered that final rule of
Keynsian Economics.

When times were good
in the 1990s – taxes
were cut.
Why be worried about the debt?

The interest we have to
pay for the debt takes
away from money we
could spend on other
things:
–
–
–
–
Schools
Roads
Health care
Infrastructure
What should be the fiscal goals of
government?






Stability- unemployment, inflation
Equity - inequality, fairness
Sustainability – resource use, balance
Growth- per capita GDP, living standard
Flexibility – ability to change and adapt
… : other needs of the society
The President’s Powers in Fiscal
Policy


Budget proposals;
program proposals
Veto power; may refuse
to spend
Congress’ Powers in Fiscal Matters



May amend/ must
approve budget
Propose programs
Power of the purse
Govt. spending breaks down to two
types:

Nondiscretionary /
Mandatory. Taxing and
spending programs
enacted by a previous
administration.
–

TRANSFER PAYMENTS:
Discretionary. Programs
making deliberate
changes in taxes and
spending.
GOALS OF FISCAL POLICY IN
2009?


Most fiscal policies are
focused on Growth and
Stability. Such policies
aim for one of two
general effects:
Increase output and
employment
–
–
Contractionary
Expansionary
Expansionary Policy



Increase spending
Increase transfer
payments
Decrease taxes
Expansionary Goals




Reach Potential Output
Reach Full Employment
Control inflation
Stimulate growth
Contractionary Goals




Reach Potential Output
Reach Full Employment
Control inflation
Stimulate growth
Contractionary Policies



Decrease government
spending
Decrease / Level
transfer payments
Lower / Raise Taxes
–
More regressive taxing?