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AP GOPO
Chapter 16
Economic Policy
Financial Reform
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.
– Recession, economy shrinks for at least six
months
Creating A Budget
• President submits a budget to Congress
by February 1
• Congress divides budget into
appropriation bills (ie Defense, Ag)
• Fiscal Year 2012 is from Oct ’11-Oct
‘12
2012 Budget
• Feb 2011 – Obama sends Budget to
Congress
• April 2011 – House passes their budget
& sends to Senate
• May 2011 – Senate Votes it Down
• August 2011 – Budget Control Act
passed
Debt Limit Agreement: Budget
Control Act
2012 Budget
• Dec 2011 – Budget Passed by making
continuing resolutions
• 2012 Total Outlays
– Obama’s Plan $3.7 Trillion
– House of Rep Plan $3.6 Trillion
– Deficit of $1.1 Trillion
Obama: 60 minutes
Federal Spending
• Discretionary Spending - Spending that
changes each Congressional year.
Money goes to FBI or Army or Highway
projects
• Entitlements (Mandatory) - Spending on
Social Security and Medicare.
Programs created by permanent law.
Good Times, Bad Times
– The U.S. economy experiences booms and
busts. The busts are called recessions.
• Recession, two or more successive quarters(6
months) in which the economy shrinks instead of
grows.
– Unemployment
• Full employment, an arbitrary level of
unemployment that corresponds to “normal”
friction in the labor market.
• Measuring Unemployment.
– Inflation
– The Business Cycle: reoccurring booms and
Good Times Bad Times
• Depression - 25% unemployment
• Depression ended the notion for
laissez-faire economics
Fiscal Policy
– Fiscal policy Congress changes spending levels
or levels of taxation. (Congress)
– Keynesian Economics
• Government Spending
• Government Borrowing
• Discretionary Fiscal Policy
• Discretionary Fiscal Policy
Fiscal Policy Theory - Keynes
• Economy enters a recession THEN the
government should run a budget
deficit
• JFK applied Keynesian Theory
• LBJ & Nixon were fiscal policy failures
• Clinton was the only president in recent
times to run a budget surplus
Supply-Side Econ
• Need for LESS govt involvement
• Lower taxes
• Arthur Laffer, Milton Friedman, Paul
Craig Roberts
Reaganomics
• Monetarism (Friedman) - increase $
supply about = to econ growth and then
let the free market operate
• Supply side tax cuts
• Domestic budget cuts
Reagan
Reaganomics Effects
• 1. Inflation was reduced BUT interest
rates increased
• 2. Personal income taxes cut BUT Soc
Sec Taxes increased
• 3. Unemployment Decreased BUT Nat.
Debt Dramatically increased
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 oneyear period.
– Are We Always in Debt?
Monetary Policy
II. Monetary policy - changes in the amount of
money in circulation to alter credit markets,
employment, and the rate of inflation.
A. Organization of the Federal Reserve System
– Loose and Tight Monetary Policies. The Fed
implements policy by increasing or reducing
the rate of growth of the money supply.
• Increasing the rate of growth is loose monetary
policy.
• Reducing the rate is tight monetary policy.
Monetary Policy
• Recession - the Fed should expand the
rate of growth in the money supply
• Do this by decreasing interest rates
Monetary Policy
• Inflationary times - Fed should decrease
the rate growth of the money supply
• This can be done by increasing interest
rates
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
• Volckernomics - tightened the money supply
–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.
The Fed
• Main purpose is to regulate the money
supply
• Created in 1913 to serve as the nations
central banking organization
• The Federal Reserve Board can be
unsuccessful (depression) or successful
(Volcker)
The Fed
• The Federal Reserve system was
created by Congress and can be altered
by Congress
• The are responsible to Congress and
provide monetary policy briefings to
Congress
• Tradition - Keep Fed independent
The Fed
•
•
•
•
Paul Volcker (Carter appointment)
Alan Greenspan (Reagan appointment)
Ben Bernanke (Bush II appointment)
7 Members to the Board who serve for
14 year appointment (staggered)
• Chairman is for 6 years
World Trade
• Since 1950 World Trade has increased
by more than 20 times
• Tariffs are taxes on imports
• Hawley-Smoot Tariff Act (1930) hurt
American business
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.
WTO
• Promote Globalization
• 140 nations
• Helps to settle trade disputes between
countries
• No country has a veto power
WTO
• http://www.youtube.com/watch?v=_mA
WslHmiok
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 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
– Loopholes reduce taxable income
• Progressive and Regressive Taxation
The Politics of Taxes
– Who Pays?
• Liberals tend to favor progressive taxes. (higher
income/higher taxes)
• Income tax and estate tax are progressive
• Conservatives either favor taxes that are less
progressive, or even flat or regressive.
• Sales tax is regressive
Social Security
• Funded by a payroll tax (currently 4.2%)
• Projected to be depleted of funds by 20402042
• Estimated that SS will have less revenue than
pay out by 2017
• SS will draw from its Trust Fund - collection of
special issue bonds - The Surplus the govt
borrowed from
The Social Security Problem
– Social Security was established in 1935 with the intent of
providing a type of insurance for a large segment of the public.
– Social Security is not a pension fund.
– Workers Per Retiree
• 1:40
• 1:3
– What Will It Take to Salvage Social Security?
• Raising payroll taxes
• Reducing benefits payouts
SS
• Social Compact between each
generation
• Politically difficult to propose to abolish
SS altogether
• Bush proposed privatization of SS taxes
into the stock market - crickets chirped
Economic Policy
• Social Security