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Stabilizing the National Economy Ch 17 Ch 17 – 1 Unemployment and Inflation I. Measuring Unemployment A. The unemployment rate is the percentage of the civilian labor force that is without jobs, but is activily seeking work. B. High unemployment is a sign that the economy is not doing well. C. Full employment is when the unemployment rate is below 5 percent. II. Inflation A. Acceptable levels of inflation are about 3 percent a year or lower. B. Unpredictable inflation has a destabilizing effect on the economy. C. Inflation can cause people’s standard of living to fall, especially people on fixed incomes, such as retired people. II. Cont. D. Demand-pull theory of inflation states that prices rise because of high business and consumer demand. E. cost-push theory of inflation states that prices rise because of excessive labor costs and business profits. F. Stagflation occurs when high inflation and unemployment at the same time. Ch 17 – 2: The Fiscal Policy Approach to Stabilization I. John Maynard Keynes: believed that forces of aggregate supply and demand operated too slowly in a serious recession, and that the government should step in to stimulate aggregate demand. II. Circular Flow of Income A. Income flows from business to households in forms of wages, rent, interest, and profits. B. Income flows back to business in forms of payments for consumer goods and services. C. Leakages - $$$ removed from economy by taxes and savings. Reduce aggregate demand D. Injections – business investments and government spending. Increase aggregate demand III. Fiscal Policy and Unemployment A. Keynesian economists believe the Great Depression was caused by a high level of leakages. B. They think the government should have increased injections of government spending or tax cuts. C. While the government did create many job programs in the 1930’s, these were not enough to make up for decrease in consumer demand. IV. Fiscal Policy and Supply-Side Effects A. Supporters of fiscal policy believe that tax cuts lead to increasing investment and jobs B. if people pay lower taxes, they will have more money to spend, save and invest in a growing economy. C. These are called supply-side effects of fiscal policy. 17 – 3 Monetarism and the Economy I. The Theory of Monetarism A. States that the Fed should increase the money supply at a smooth, given percent per year. B. If the economy operates below capacity, the extra demand that results from the increase in the money supply will lead to a rise in output. C. Businesses will hire more workers and unemployment will decrease. D. If there is full employment, however, the increased demand will lead to inflation. II. Government Policy According to Monetarists A. Monetarists oppose using fiscal policy as a way to control the economy because the economy is so complex and so little understood. B. They want the government to balance the federal budget, so that the government would not be competing with business for loans. II. Cont C. They want the Fed to stop smoothing the ups and downs in the economy. D. They want the Fed to allow the money supply to grow at a steady rate. E. Monetarist theory actually influenced the Fed’s policies during the 1980’s. III. Monetarists’ Criticism of Fiscal Policy A. The theory of fiscal policy is not the reality B. No single government body designs and implements fiscal policy. C. Since there are differences of opinion about what fiscal policy to institute, no single policy is actually enacted. III. Cont. D. There is a time lag between when a policy is enacted and when it is finally implemented. E. If the policy is implemented too late, then it has the opposite affect.