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 busts

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 one-year 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=_mAWslHmiok

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 2040-

2042• 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