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Economic Policymaking
How should our government direct fiscal and
monetary policy to achieve our economic goals?
So why should I care about the
economy?
Current numbers:
U.S. population: 316,998,190 (July 2013)
Inflation: 1.1% (Feb. 2014)
Unemployment: 6.7% (March 2014)
Growth rate: 2.6 % (Q4—2014)
Deficit: $564 Billion (down from $1.4 Trillion
in 2009)
Debt: $17.5 Trillion
http://www.usdebtclock.org/
What kind of an economy do we have, anyway?
Who’s in control?
Capitalism/Free market
VS.
Mixed-Economy
The federal government plays an important
role in affecting the health of the economy
Fiscal Policy: The use of spending and taxation to
stimulate or slow down the economy.
Who should control the economy?
The consumer or the government?
Liberals tend to
favor more
government
involvement in
the economy.
Conservatives tend
to favor less
government
involvement in the
economy.
Demand-Side Economics
• What’s the big idea?
– Economy composed of 3 sectors-businesses, individuals and
government
– Government actions can make up for changes in other 2
•
Who’s the Economist behind the idea?
– John Maynard Keynes
• What’s the Theory?
– Government spending, tax cuts and deficits help the economy
weather its normal ups and downs.
• What’s the role of the Government?
– Government’s job to increase demand of goods
Supply-Side Economics
• What’s the big idea?
– Taxes have a strong negative influences on economic output.
– Consumer stimulates the economy by spending money
• Who’s the Economist behind the idea?
– Milton Friedman
• What’s the Theory?
– There is too much taxation and not enough money to purchase
goods and services.
– Reduce taxation and government regulation then people will
work harder
• What’s the role of the Government?
– To increase the supply of goods
How does the economy control voter
behavior?
– Economic trends affect who the voters vote for
– Economic conditions are the best predictor of
voters’ evaluation of the President
What does everyone (voters and
politicians) want to control?
–Unemployment rate
–Inflation
–Consumer Price Index
How do Congress and the President
work to “control” the economy?
– Fiscal Policy: The policy that describes the
impact of the federal budget on the
economy.
How would you summarize this
statement about the government
and the economy?
“Capitalism is the astounding belief that the
most wickedest of men will do the most
wickedest of things for the greatest good of
everyone.”
How would you summarize this
statement about the government
and the economy?
“I am favor of cutting taxes under any circumstances
and for any excuse, for any reason, whenever it's
possible.”
There are two tools of Fiscal Policy
Taxes
Income tax
(Progressive)
Sales
Payroll
Property
Spending
Budget/government
programs
Subsidies
What should the government do if…
Unemployment is 8%
GDP is 1.6%
Inflation is 2%
Unemployment is 4%
GDP is 4%
Inflation is 8%
STIMULATE THE
ECONOMY!
SLOW DOWN THE
ECONOMY!
AKA Expansionary Fiscal
Policy
AKA Contractionary Fiscal
Policy
Fiscal policy desicions
Expansionary Fiscal Policy:
Decrease taxes
Increase spending
Result: Consumers have
MORE money to spend!
Contractionary Fiscal
PolicY:
Increase taxes
Decrease spending
Result: Consumers have
LESS money to spend!
What is “the FED” (Federal
Reserve)?
• The main instrument for making monetary
policy in the US.
• Created in 1913 to regulate banks and money
supply (stop PANICS!)
• Seven Members of Board of Governors
• Located in Washington with 12 reserve banks
around US.
• Appointed by President to 14 year term; must
be approved by Senate
How can the the FED “control” the
Economy?
• Monetary Policy and “the Fed”
– It manipulates the money supply in private hands
– too much cash and credit produces inflation.
– Current Chairman of the Fed: Ben Bernanke
How does “The FED” control the
economy?
– The Fed uses tools to influence the supply of
money in circulation:
• Sets prime credit rate (PCR)
• Sets reserve requirements (RR)
• Open Market Operations (OMO)
Use of these tools helps to EXPAND or
CONTRACT the economy.
The Fed uses three tools to conduct
monetary policy
1. Reserve Requirement
2. PRIME CREDIT RATE
3. Open Market Operations
All three of these tools use BANKS to control the
amount of money in the economy.
All three of these tools use BANKS to control the
amount of money in the economy.
• INTEREST- The interest rate is the amount
banks charge us to borrow from them.
• Banks generally charge HIGHER interest rates
when they have LESS money, and LOWER
interest rates when they have MORE money.
• Why do you think they do this?
The Reserve Requirement is the minimum
amount of funds banks must keep in their vaults
= LESS money to lend out, so will they charge higher
interest rates to us for the money they DO lend out.
= MORE money to lend out, so will they charge lower
interest rates to us for the money they lend out.
The Prime Credit Rate is interest the FED
charges banks to borrow money
Once banks know how much the FED will charge
THEM to borrow money, they decide how
much to charge US to borrow (i.e. interest).
Generally, the following rules apply:
= LESS money to lend out, so will they charge higher
interest rates to us for the money they DO lend out.
= MORE money to lend out, so will they charge lower
interest rates to us for the money they lend out.
Open-market operations is the most successful
and often used tool of monetary policy
Buying Bonds
Money Supply
Selling Bonds
Money Supply
Buying and selling bonds has two different
effects on the economy and consumers.
When the Fed BUYS bonds
it is PUTTING MORE
MONEY INTO the
economy.
How will banks respond to
this?
By charging us LOWER
interest rates!
We will borrow MORE
money!
When the Fed SELLS
bonds it is TAKING
MONEY OUT of the
economy.
How will banks respond to
this?
By charging us HIGHER
interest rates!
We will borrow LESS
money!
What should the Fed do if…
Unemployment is 8%
GDP is 1.6%
Inflation is 2%
Unemployment is 4%
GDP is 4%
Inflation is 4%
STIMULATE THE
ECONOMY!
SLOW DOWN THE
ECONOMY!
AKA Expansionary
Monetary Policy
AKA Contractionary
Monetary Policy
Monetary policy decisions
Expansionary Monetary
Policy:
-Decrease the Reserve
Requirement
-Decrease the discount
rate
-Buy Bonds
Result: Banks have MORE
money to lend, and
consumers have MORE
money to spend!
Contractionary Monetary
Policy:
-Increase the Reserve
Requirement
-Increase the discount rate
-Sell bonds
Result: Banks have LESS
money to lend, and
consumers have LESS
money to spend!
Economic Policymaking
1. Who’s in control of our money?
2. How does this relate to politics?