5-14-12*********** New Test information

1. Short run gov’t policya. What should the gov’t do about a recession?b. Why should they not do it?

i. In the context of the Phillips Curve1. Looks at the connection between Inflation and unemployment

c. In the timeline of the 20th centuryi. Theories

ii. Economyiii. Policy

Short run Phillips Curve

Long run Phillips Curve

2. 1960 recessiona. 1961- Kennedy elected

i. Appointed 2 policy teams1. Monetary team- Money (controlled by the fed)2. Fiscal- Spending, Taxing, and deficits (controlled by congress)

ii. Used D.A.S.K. Policies 1. Discretionary- you get to choose2. Activist- gonna actively manipulate the economy(laissez faire is do

nothing)3. Stabilization- Attempt to make the economy stable4. Keynesian- policy based on Keynesian theory(Above Phillips Curves)

iii. How to DASK1. In a recession- need to increase Aggregate Demand (C,I,G or NX)

a. Fiscal- Spending: spend more, Taxing: tax less, By default deficit will rise

b. Monetary- Inject money to increase inflation and bring down unemployment (Keynes theory). This will lower interest rates since people will save since prices don’t adjust immediately due to stickiness. Lower interest rates will increase demand.

2. This begs the question- how much?a. Just enough…

iv. Recommendations1. Fiscal- Tax cut2. Monetary- Inject lots of money.

a. The amount increased every year. By the time of the end of his policy, inflation was near 7%

v. Due to these policies1. Inflation rose2. Unemployment fell. By 1969 got down to 3.4%

vi. Two conclusions1. Keynes was right2. DASK works

b. Why not DASK?i. Because it’s DUM

1. Delaysa. There is a lag between when we enter a recession and our

policies take effecti. Need to Recognize a problem, decide what to do,

implement changes, economy is slow to react2. Unintended Consequences

a. Generali. Trying to fix something but you make it worse

ii. Fix something, but in that process you break something else

b. Rules vs. Discretioni. Non-economic policies

1. Discretion opens the door to manipulation2. People don’t like to go without due to the rules

ii. Economic policy1. Monetary- If the fed has discretion, they will try

to manipulate the economy to get lower unemployment by having higher inflation (misperception requires people to be surprised)

a. If people expect it, This locks us into higher inflation without the lower unemployment(inflation trap/ Inflationary bias)

b. Rules are required to prevent this2. Fiscal policy

a. When given discretioni. Politicians manipulate

voters(this brings “the political business cycle”- the business cycle that is booming around elections)

ii. Special interest groups manipulate politicians( this brings “rent seeking”-seeking a payback for campaign contributions)

b. Rules prevent these3. Mistakes

a. Theoriesb. Policy-

i. not a dependable trade off between Unemployment and Inflation

ii. Deficit spending- see below c. Economy

3. 1970’sa. Stagflation- High inflation and High unemployment

i. It contradicts Keynesian theoryb. The process of change to multiple Phillips Curves

i. Recession starts in 1969

ii. To try to control upward price/wage spirals, Nixon made it illegal to raise anyone’s wages and prices. 1971-72

iii. Nixon removed in 1974. Johnson tried to stop inflation. WIN(whip inflation now)iv. 4 Recessions in the 70’s finished the move

4. Deficit spendinga. Short run-

i. Stimulate demandii. Lower unemployment

b. Long run- Causes crowding outi. Reduce supply of funds

ii. Raise interest ratesiii. Reduce demand

c. Deficit spendingi. Have to borrow $100 Billion

1. On one handa. Spending Increases ADb. This will increase Income

Multiple

Phillips

Curves

i. This will increase Consumption1. This increases Demand

a. The circle is complete and it perpetuates itself

c. After several times around the money has multiplied up to $600 Billion

d. Theory only works in the short run when we are below full employment

e. Same as trickle down economicsf. Proven to not work in the long run

2. On the other handa. Borrowing raises taxes

i. This raises AD1. This causes crowding out