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6. Why is inflation bad:
Some things are indexed for inflation. Adjustable rate
mortgage, cost of living adjustments. unpredictability.
Lending money becomes precarious. Less incentive to
save money in the bank. Affects the economy by limiting
the amount of capital out there to invest and borrow.
Decreases productivity.
7. Hyper inflation:
Germany 1920s – led to National Socialist German
Workers’ Party. Argentina, Israel, Boliva in the 1980s.
400% inflation; 14% a month.
Why Government Is Involved in the Economy
And Social Welfare
1. Economic management
– a. Governments in all modern capitalist societies play a
substantial role in the management and direction of their
economies.
– b. Government responsibility for the national economy is
so widely accepted that national elections are often decided
by the voters’ judgment of how well the party in power is
carrying out this duty.
– c. Keynesian economic policy - The management of
aggregate demand : when unemployment is high and
demand is low government should increase spending and
lower taxes. When demand is high, inflation is high,
government should cut spending and increase taxes.
2. Minimizing "Diseconomies"
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the environment
•
workplace safety
•
food safety/product safety
3. Promote Public Goods/solve collection action problems
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managing the federal government's natural resources
–
–
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a. the National Forests
b. the National Parks
Support scientific research
4. Interest Group Pressure
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corporate subsidies
–
–
a. agriculture - Farmers, Campbell soup, Pet foods
b. research and development grants
5. Promote Growth
• military spending - military Keynesianism
• human capital - education/health
• physical resources (public works projects)
• increase savings via incentives
6. Promote Stability
• Criminal Justice System
• Federal Judicial System
7. Promote Values
• progressive tax
• tax sinful products
• $100 million to promote health marriages
Tools of Macroeconomic Policy
• Monetary policy — government policy to
influence interest rates and control the supply of
money in circulation, primarily accomplished
through the operations of the Federal Reserve
Board
• Fiscal policy — altering government finances by
raising or lowering government spending, raising
or lowering taxes, and raising or lowering
government borrowing
– Fiscal tools are not easy to use.
– Many issues come into play in setting fiscal
policy.
• Federal spending cannot be easily adjusted up or
down.
• Tax rates cannot be easily adjusted.
• Changes in spending and taxes take so long to
accomplish that there is danger that the policies will
be inappropriate by the time they filter into the
economy.
I.
Fiscal Policy (Taxing and Spending)
A.
Spending Policy
•
Defense (19%), Social Security (21%), Medicare spending
(13%), medicaid (8%) and interest payments (13%) on past
borrowing. This makes 74% of the total budget; the
remaining 26% is allotted to such things as housing, foreign
aid, etc. (4 billion for housing and services for the homeless)
B. Taxation Policy
•
95% of the total, are individual income taxes (46%),
Corporate income taxes (12%), payroll taxes for Social
Security and Medicare (34%), and excise taxes on gasoline,
cigarettes and alcohol (3%). The remaining 5% of taxes
includes such things as estate taxes, custom fees, etc.
Death and Taxes
•
Corporate taxes have been reduced to half of what they
were in 1960. Excise taxes have reduced to a third and
social insurance/payroll taxes have doubled. Individual
contributions have remained about the same.
•
1. Progressive taxation
Taxpayers by
income
top 1%
Top 5%
top 10%
top 25%
top 50%
bottom 50%
1993 adjusted
gross income
AGI
above $185,791
above $87,154
above $66,196
above $41,192
above $21,158
below $21,158
share of
AGI
13.8%
27.8
39.1
62.5
85.1
14.9
Share of
income
taxes
28%
47.3
58.8
79.2
95.2
4.8
2. Flat taxation - Would benefit the rich by far. Would increase
middle class tax rate. Unless all loopholes are closed.
3. Regressive taxation - lower-income earners pay higher
percentage
4. Payroll Taxes - Social Security
5. Excise Taxes
6. Corporate Taxes - easy target for liberals
7. Loopholes for the wealthy and corporations (and middle class)
8. An Assessment: Progressive, Flat, or Regressive?
Tax Receipts as a % of GDP
The Federal Budget and Fiscal Policy
• Government spending
• Federal government spending in 1999
– Fourfold increase since 1960 in constant dollars
– Expansion of federal outlays as a proportion of
GDP from 18% to about 19%
The Deficit and the National Debt
• The budget deficit is the annual shortfall
between what the government spends and what
it takes in.
• The national debt refers to the total of what
the government owes.
C. Deficit and the National Debt
•
The accumulated debt as a % of GDP in 1946 as
114%. This number fell to 46% in 1960 and to 26%
by 1980. Deficits usually were small when they
accrued until a reversal occurred, and the number
rose to 37% in 1985 and to 52% in 1995,though
more recently has started to level out
•
Is it Bad?: MAYBE, MAYBE NOT
II. Monetary Policy - the value of currency
•
The FED controls monetary policy, which refers broadly to money, the
interrelationship of money with the banking system, and interest rates.
A.
The Federal Reserve Board (FED)
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Quasi-public corporation - Chairman. Appointed - 4 year term.
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Other members: 7 of the 12 Board of Governors are appointed for one
14 year term; 5 are selected from the regional Federal Reserve Banks
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Actions by the Fed affect how much money is available to businesses
and individuals in banks, savings and loans, and credit unions.
•
It influences interest rates and the money supply.
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How the Fed sets monetary policy
• Open market operations
• Discount rate
• Reserve requirements
B. Control of the money supply
1. First - What is money?:
– Economic Definitions of Money:
• M1: currency, traveler's checks, checking
accounts. Called narrow money - 1/8 of GDP
• M2: Includes everything in M1, plus savings
accounts and money market mutual funds.
M2 = about 1/2 of the GDP
• M3: Includes everything in M2, plus cds and
other deposits.
C. FED Tools to affect money supply
•
1. Reserve requirement: every bank is required to keep
some of its deposits on reserve at the central bank; they
do not receive interest on these deposits. If this reserve
requirement is raised, then banks have less money to
lend out and interest rates will rise.
•
2. the discount rate: if a bank has loaned most of its
funds, it may not have enough on hand to deposit wit the
central bank to meet the reserve requirement. If a bank
needs or wished to borrow from the central bank, then
the interest rate that it is charged is called the discount
rate.
•
3. Open Market Operations: involve buying/selling
government securities and Treasury bonds. If the Fed
sells bonds to banks, then banks have the bonds, but they
also have less money (type M1) to lend and will charge
higher rates.
•
4. Movement of Checks: Fed is responsible for the
physical movement of checks through the clearing
system
D. Effects of Monetary Policy
• 1. Expansion of monetary supply will reduce interest rates,
stimulate aggregate demand in the economy, create jobs and
thus reduce cyclical unemployment.
• 2. tighter monetary policy that reduces the money supply will
raise interest rates, reduce aggregate demand, and reduce
inflation.
• 3. Low and stable interest rates proved a good framework for
long-term investment decisions and sustained economic
growth
The FED and Democracy:
• The Fed has great power over the U.S. economy,
even over the world economy, yet it is run by
presidential appointees and bankers, and its policy
decisions are not voted on by Congress or other
publicly elected officials. Although there are
plausible reasons for this lack of direct democratic
accountability, it is an ongoing source of
controversy.
• Why do we give the Fed authority it has?
Alternatives to an Appointed FED
• Democratic vote on monetary policy: no nation uses a
democratic, legislative vote to make monetary policy
decisions. The fear is that elected representatives would find it
nearly impossible to vote for higher interest rates, and the
result would be that the economy had a bias toward letting
inflation get established.
• Fixed rules: fixed rules as to when the money supply would
be allowed to grow (in accordance with the rate in growth of
the economy). But new financial innovations (e.g., credit
cards) have somewhat scrambled the relationship between
money and GDP, so these rules look less reliable now.
• Price stability: Congress or an elected body sets an inflation
target for the Fed or some other central bank to meet. The
central bank focuses only on the inflation target and uses its
tools to try and meet the target. If I doesn't, its leaders can be
dismissed.