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Economic Policy

The Budget, the Fed, and a sundry other important economic points

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I. The BudgetA. In Theory: how much will be collected in taxes, and how

that $ will be spent on programsB. In Fact: a list of what will be spent on whatC. Before 1921

1. Congress prepared “budget” alone2. Highly decentralized process; many committees involved3. Committees could increase or decrease amounts at will4. President simply approved appropriations bills

D. Budgeting and Accounting Act of 19211. Placed responsibility for preparing budget on President2. Created Bureau of the Budget (became OMB in 1970)

E. Council of Economic Advisers—created in 1946 1. 3 economists advise president on maintaining a stable economy2. Helps president prepare annual economic report3. Promotes the president’s policy goals

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I. The Budget ContinuedF. Budget Act of 1974

1. Further organized budget process; Congress retook power2. Budget resolutions est. ceilings for spending areas3. Created CBO4. Committees approve appropriations; Congress passes

them; President signs

G. Office of Management and Budget1. Located within Executive Office of the President2. Director appointed by president, approved by Senate3. Staff of over 500—they begin budget process in spring by

meeting with the president4. Based on president’s priorities, the OMB assembles a

budget by working with agencies. The OMB scrutinizes agencies’ requests

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I. The Budget ContinuedH. Congress and the Budget Process

1. Budget must be approved by Congress

2. Budget Committees (2) review the whole budget

3. CBO—analyzes and makes proposals

4. Budget Resolution—used to propose budget ceilings—Congress adopts these to guide future work on the budget

5. Portions of the budget are sent to authorization, tax, and appropriations committees

a) Within the House and Senate, there are 35 committees that can authorize spending according to their expertise

b) Appropriations committees allocate the funding

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II. TaxationI. The Politics of Taxation

1. Income tax authorized by 16th amendment (1913)

2. Tax rate lower in US than other democracies

3. Income tax burden is progressive; other taxes are not

4. Tax loopholes—Client politics

a) Reformed by Tax Reform Act (1986)—low rates, fewer deductions—entrepreneurial politics

b) Reagan wanted to reduce taxes

c) Bush and Clinton both raised taxes

d) New loopholes created

5. Transfer paymentsa) From wealthy to poor; economic equality

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III. The Fed (Federal Reserve Board)A. An independent agency est. in 1913 by Federal Reserve

ActB. Primary job—monetary policyC. Structure of the Fed

1. Board of Governors (aka FRB)a) 7 members; 14 year termsb) Chairman (Ben Bernanke): 4 year termsc) All appointed by President, confirmed by Senated) Responsibilities: set reserve requirements

2. FOMC (Federal Open Market Committee)a) 12 members including FRBb) 8 meetings/year to discuss monetary policyc) Responsibilities:

• Set securities rate—the rate member banks buy and sell government securities• Set discount rate—the rate the Fed charges banks for loans (aka interest rate)

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III. The Fed (Continued)d) Buying—puts $ into circulation; interest rates drope) Selling—takes $ out; interest rates increasef) This encourages or discourages borrowing and thus

business expansion• Lower rate=more borrowing=more $=inflation/stimulation• Higher rate=less borrowing=less $=slows inflation

g) Banks set “prime rate” based on the discount rate• This affects all money borrowed from a bank

h) Historically—combats inflation more than stimulates economy: • “to remove the punch bowl when the party gets going”

3. 12 Regional Banks and 25 branchesa) Operate like the government’s banker b) Responsibilities:

• Store excess currency (reserves)• Settle checks and payments• Sell securities

c) 6,000 member banks(See: http://money.howstuffworks.com/fed.htm)

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The Board of Governors

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The FOMC

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The Federal Reserve Banks

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Reserve Requirements

More currency

Too much of this leads to…

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Which leads the Fed to…

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Money comes out of the system, goes to Fed

Less $ in circulation leads to higher interest

rates

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But, if interest rates climb too high…

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Now banks have more money to loan which drives down

Interest Rates

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In Summary…

The Fed affects monetary policy by:

1)Buying or selling securities

2)Changing the reserve requirements

3)Adjusting the discount rate

All of these change the supply of money and indirectly change the interest rate