CHAPTER 13QuestionsSlide 3Government PolicyMonetary Policy InstitutionsSlide 6Figure 13.1 - Structure of the Federal Reserve SystemFigure 13.2 - Composition of the Federal Open Market CommitteeSlide 9Slide 10Slide 11Fiscal Policy InstitutionsFigure 13.4 - The Budget ProcessGovernment ExpendituresFigure 13.5 - Major Federal Government Expenditures by Category, 1960-2000Figure 13.6 - Federal Government Discretionary Spending, Excluding Defense (2000)Slide 17The History of Economic PolicySlide 19Slide 20Figure 13.7 - The U.S. Phillips Curve(s), 1955-1980Slide 22Figure 13.8 - The Velocity of Money before 1980The Power and Limits of Stabilization PolicySlide 25The Lucas CritiqueLeading IndicatorsFigure 13.9 - Different Measures of the Money Stock Behave DifferentlyThe Money MultiplierSlide 30Figure 13.10 - Changes in the Currency-to-Deposits RatioLong Lags & Variable EffectsMonetary vs. Fiscal PolicySlide 34Automatic StabilizersHow Monetary Policy WorksSlide 37Rules vs. AuthoritiesFigure 13.11 - The Politically-Influenced Business Cycle: Relative Growth in the Second Year of Presidential TermsCentral Bank IndependenceFigure 13.12 - Inflation and Central Bank Insulation from PoliticsCredibility & CommitmentSlide 43Modern Monetary PolicySlide 45Financial CrisesSlide 47Slide 48Lender of Last ResortDeposit InsuranceChapter SummarySlide 52Slide 53Slide 54Slide 55Slide 56Slide 57Slide 58Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-1CHAPTER 13Stabilization PolicyCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-2Questions•What principles should guide stabilization policy?•What aspects of stabilization policy do economists argue about today?•Is monetary policy or fiscal policy more effective as a stabilization policy?•How does uncertainty affect the way stabilization policy should be made?Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-3Questions•How long are lags associated with stabilization policy?•Is it better for stabilization policy to be conducted according to fixed rules or to be conducted by authorities with substantial discretion?Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-4Government Policy•There are two kinds of government policy–fiscal policy•shifts the IS curve–monetary policy•shifts the LM curve•The government uses policy to stabilize the macroeconomy by minimizing the impact of shocksCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-5Monetary Policy Institutions•Monetary policy in the U.S. is made by the Federal Reserve which is the central bank–the principal policy-making body of the Federal Reserve system is the Federal Open Market Committee (FOMC)•the FOMC lowers and raises interest rates and increases and decreases the money supplyCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-6Monetary Policy Institutions•The Federal Reserve has a central office and 12 regional offices–the central office is the Board of Governors in Washington, DC–the 12 regional offices are the 12 Federal reserve banks scattered around the U.S.–the members of the Board of Governors and the Presidents of the regional Federal Reserve Banks make up the FOMCCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-7Figure 13.1 - Structure of the FederalReserve SystemCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-8Figure 13.2 - Composition of the Federal Open Market CommitteeCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-9Monetary Policy Institutions•The FOMC meets approximately once a month to set interest rates–emergency meetings can also be scheduled on short notice•When the FOMC decides on a policy change, it is implemented immediately–it takes only minutes for interest rates to shift in response to FOMC actionsCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-10Monetary Policy Institutions•The FOMC changes interest rates by carrying out open-market operations–in an expansionary open-market operation, the Federal Reserve buys government bonds, increasing bank reserves, and lowering interest rates–in a contractionary open-market operation, the Federal Reserve sells government bonds, decreasing bank reserves, and raising interest ratesCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-11Monetary Policy Institutions•The Federal Reserve can also alter interest rates in two other ways–the Board of Governors can alter legally required bank reserves–the Board of Governors can lend money directly to financial institutions•These tools are used very rarelyCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-12Fiscal Policy Institutions•Fiscal policy in the U.S. is managed by Congress–the Congress creates the tax laws that determine the amount of taxes imposed by the federal government–the Congress’s spending bills determine the level of government purchases•Tax and spending levels are set through a process called the budget cycleCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-13Figure 13.4 - The Budget ProcessCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-14Government Expenditures•Mandatory expenditures include spending for Social Security, Medicare, Medicaid, unemployment insurance, and food stamps•Discretionary expenditures must be appropriated each year by Congress–these include defense spending, NASA, highway spending, education spending, and so forthCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-15Figure 13.5 - Major Federal Government Expenditures by Category, 1960-2000Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-16Figure 13.6 - Federal Government Discretionary Spending, Excluding Defense (2000)Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.13-17Fiscal Policy Institutions•Because of the way the budget process is set up, making fiscal policy in the U.S. is complicated and time-consuming–the time between when a policy proposal is made and when it becomes effective (the inside lag) can take years–the inside lag associated with monetary policy changes can be measured in days or weeksCopyright © 2002 by The McGraw-Hill Companies, Inc. All rights