Chapter 17Stabilizing the National Economy

Chapter Objectives Understand why unemployment and

inflation are two major threats to a nation’s economic stability (17-1)

Know how government taxation and spending can stimulate/slow economic growth (17-2)

Understand the theory used by the Fed that controls the money supply to stabilize the economy (17-3)

Measuring Unemployment UNEMPLOYMENT RATE

Percentage of civilian labor force that is unemployed BUT actively seeking work

One of the statistics used to measure the health of our economy

REMEMBER…not everyone is included in the labor force Students, retirees, long-term hospital

patients Four distinct types of unemployment

Inflation

Demand-Pull Inflation Prices rise as the result of excessive

business & consumer demand Demand increases faster than total

supply Results in shortages

Leading to higher prices

Basically, creates a “bidding war” over goods due to a shortage Thus DEMAND for goods PULLS the

prices up

Cost-Push Inflation Higher wages push prices up

Inputs (wages) increase Production cost rise

Price of goods increases to compensate

Rising COST PUSH price levels up

STAGFLATION Combination of inflation and stagnation

Stagnation is low economic activity

Circular Flow ofIncome & Output FISCAL POLICY

Federal government’s use of taxation & spending policies to affect overall business activity

John Maynard Keynes Developed fiscal policy theories during

the Great Depression Believed forces of aggregate

supply/demand moved to slowly Government should help stimulate

aggregate demand

Circular Flow ofIncome & Output

Economic model that pictures income as flowing continuously between businesses & consumers

Not all income follows the circular flow LEAKAGES

Money that leaves the circular flow Savings & Taxes

INJECTIONS Money that enters the circular flow

Business Investments & Government Spending

The Supply-Side Effects Opposite Keynesian Theorist Believe in

Less government involvement Less Taxes

Leave more money IN the economy Used to stimulate private investment Grow our employment levels

The Supply-Side Effects Named this way because…

They affect the supply of key ingredients of economic growth

President Bush used this argument to promote his “Jobs & Growth Tax Act” (‘03) Features were aimed at increasing economic

growth Tax rates fell effective January 2003 Highest tax rate fell from 39.6% to 35% Tax on dividends fell from 39.9% to 15% Capital Gains tax fell from 20% to 15% Low-Income earners tax rate fell to 5%

Monetarism Theory that deals with the relationship

between the amount of money the Fed places in circulation and the level of activity in the economy

Often tied to economist Milton Friedman Believe the money supply should be

used to influence the economy Fed increases the money supply at a

given percent each year

Monetarism Argue that too much money released too

quickly will Force the economy to expand too rapidly Encourage people to borrow more & spend

more Which will…

Raise outputs & businesses will hire more workers

Bring down unemployment However if we are already at full employment

This will cause prices to rise Inflation will occur

Government Policy Interpreted by Monetarists Friedman (monetarists) believe the

economy is too complex & misunderstood Government does more harm than good Should be left up to businesses &

consumers Oppose Fiscal Policy to stimulate/slow

economic growth Believe the Fed should stop trying to

smooth the ups & downs of the economy

Monetary Rule The fed should allow the money supply to

grow at a smooth, consistent rate per year and not use monetary policy to stimulate/slow the economy

Believe in steady growth with strict guidelines Best way to provide

businesses/consumers with more certainty in an economic future

Result would be controlled expansion

Monetarists’ Criticismof Fiscal Policy Cannot be implemented effectively

No single government body designs & implements President recommends course of action Congress enacts fiscal policy

Politicians may make decisions today to get reelected May hurt economy in long run

Time Lags May take months or years for policy to

stimulate the economy