Economic PolicyLearning Objectives: Economic PolicyKey Terms: Economic PolicyWhat Government Does: Budgeting, Taxation, and Fiscal PolicySlide 5Slide 6Slide 7Fiscal and Monetary PolicyFiscal Policy DefinedSlide 10How Does Fiscal Policy Work?Using Fiscal PolicySlide 13Limits to Fiscal PolicyTools that influence Fiscal PolicyFederal Fiscal PolicyWhat is Monetary Policy?Instruments of Monetary PolicyMonetary Policy and Economic GrowthSlide 20Monetary Policy and Low InflationMonetary versus Fiscal PolicyCentral Banking and Federal Reserve SystemCentral Banks and Monetary PolicyThe Role of Central BanksHow Banks ‘Create Money’ - the Fractional Banking SystemCentral Bank IndependenceCentral Banking in the U.S.: The Federal ReserveThe Federal ReserveSlide 30Slide 31Budgeting: Taxing and SpendingFederal BudgetingSlide 34Slide 35Slide 36Slide 37Federal Budgeting: TaxesSlide 39Fiscal Balances for Selected CountriesGovernment spending as a % GDPSlide 42Slide 43Slide 44Debt and DeficitsFederal Budgeting: Debt and DeficitSlide 47Slide 48Slide 49Slide 50Slide 51General Government Debt as a % of GDPGoals of Fiscal PolicySlide 54Slide 55Slide 56Slide 57Slide 58Slide 59Slide 60Slide 61Slide 62Review QuestionsDiscussion QuestionsEconomic PolicyEconomic PolicyLearning Objectives: Economic Policy•We will discuss American Economic Policy by looking at:–Fiscal and Monetary Policy–Federal Reserve System –Budgeting – Taxing and Spending–Debt and Deficits–Goals of Fiscal Policy–Trade Issues – Globalization, Balance of Payments, ProtectionismKey Terms: Economic PolicyKey Terms: Economic Policy•Fiscal Policy•Monetary Policy•Supply-Side Economics•Keynesianism•Chicago School•Laffer Curve•Federal Reserve System •Income Taxes•Sales Taxes•Property Taxes•Debt•Deficits•Globalization•Balance of Payments•Protectionism•Free Trade•Office of Management and Budget•Congressional Budget Office•Regressive Taxes•Progressive Taxes•Quantity Theory of Money•GATT•NAFTA•WTO•FTAA•Discount Rate•Prime Rate•“It’s the Economy, Stupid…”•“Sin” Taxes•Inflation•Hyperinflation•Stagflation•Unemployment•“Black Budget”•Counter-Cyclical Policy•Gross Domestic Product (GDP)What Government Does: Budgeting, Taxation, and Fiscal Policy•Generally, the U.S. Government’s Generally, the U.S. Government’s involvement in the economy is three-fold:involvement in the economy is three-fold:•To engage in To engage in Economic ManagementEconomic Management•To ensure To ensure Economic StabilityEconomic Stability•To provide a To provide a Legal Enforcement StructureLegal Enforcement StructureWhat Government Does: Budgeting, Taxation, and Fiscal Policy•Economic PolicyEconomic Policy–GoalsGoals•Economic growthEconomic growth•Low unemploymentLow unemployment•Price stabilityPrice stability•Positive balance of paymentsPositive balance of payments•Minimizing diseconomiesMinimizing diseconomies•Supporting key economic sectorsSupporting key economic sectorsEconomic Policy•Principal Economic Policy Perspectives in the U.S.:Principal Economic Policy Perspectives in the U.S.:•Keynesianism – Keynesianism – Liberal–Manipulation of government spending/taxing to impact the economy•Monetarism – Monetarism – Conservative–Manipulation of the money supply to impact the economy•Supply-Side – Newer conservative view Supply-Side – Newer conservative view –Belief that tax cuts stimulate the economy and increase Belief that tax cuts stimulate the economy and increase government revenues over timegovernment revenues over timeEconomic Policy•Economic Policy ToolsEconomic Policy Tools–Fiscal policyFiscal policy•TaxesTaxes•SpendingSpending•Deficits/DebtDeficits/Debt–Monetary policy Monetary policy •The Federal Reserve BoardThe Federal Reserve BoardFiscal and Monetary PolicyFiscal and Monetary PolicyFiscal Policy Defined•Fiscal policy is any government action that affects govt. spending or revenue.•John Maynard Keynes provided the rationale for the use of fiscal policy to stabilise economic growth.•Active use of fiscal policy was popular with governments from the 1950s to mid-1970s.Fiscal Policy Defined•If government revenue > government spending = Government budget surplus.•If government revenue < government spending = Government budget deficit.•Are deficits bad or are surpluses good?How Does Fiscal Policy Work?How Does Fiscal Policy Work?•Fiscal Rule: Govt. spending and/or  Taxes when economy is in recession. Govt. spending and/or  Taxes when economy is booming.•Aim of this type of counter-cyclical fiscal policy is to ensure low unemployment.Using Fiscal PolicyUsing Fiscal Policy•A government needs to know a lot of information before it uses fiscal policy. •In particular it needs to know:–Potential output–Actual output–The value of the multiplier for the economy.Using Fiscal Policy•What is the final effect on the economy of an increase in government spending of $10 billion dollars?•An increase of $10 billion dollars will lead to a bigger increase in final output – a multiplier.•Initial increase in spending  multiplier = final increase in demand.•End Result: Stronger economy.Limits to Fiscal Policy•Time lags–Decision and implementation lags•Political interference•Inefficiencies of the public sector•Government debt has to be repaid.•Past experience–Example: the oil-price shock of the 1970sTools that influence Fiscal PolicyTools that influence Fiscal Policy–Spending levelsSpending levels–Spending prioritiesSpending priorities–Taxation (levels, types)Taxation (levels, types)–The tax system (federal, state, and local)The tax system (federal, state, and local)–Budget deficitsBudget deficits–TThe national debthe national debtFederal Fiscal PolicyFederal Fiscal Policy•People and Organizations who influence People and Organizations who influence economic policyeconomic policy•Governmental actorsGovernmental actors–The PresidentThe President–CongressCongress–The Federal Reserve BoardThe Federal Reserve Board•Societal actorsSocietal actors–Interest groupsInterest groups–Public opinionPublic opinion–Political partiesPolitical partiesWhat is Monetary Policy?What is Monetary Policy?•Monetary policy is policy that affects the money supply or the rate of interest in order to affect the level of aggregate demand in an