Fiscal Policy

Fiscal Policy

Fiscal Policy: The use of (Tools): 1. government expenditure (spending) 2. revenue collection (taxation) to stabilize the business cycle.

Who makes fiscal policy in the United States?

The President and Congress (State Reps and Senators).

Fiscal Policy How does the

Government get money?

Taxes!!!

What does the government spend money on?

Lots of things: Military, highways, education, welfare, policemen, firemen, social security, etc.

Fiscal Policy

Ok, here’s how it works:

First, Remember the business cycle?

Fiscal Policy

When the country is at a “peak” in the business cycle, it means that people have “too much” money.

What do you mean Mr. Wharton??? Why is that bad?

Because it leads to inflation (a rise in prices), which can ultimately lead to a recession.

Fiscal Policy

How does the President and Congress use government spending and taxation to prevent people from having “too much” money?

1. They decreases spending.2. They increase taxes.

Fiscal Policy

When the country is at the “trough” stage of the business cycle, it means that people don’t have enough money.

Fiscal Policy

How does the President and Congress use government spending and taxation to put more money in people’s pockets?

1. Increase government spending2. Decrease Taxes

3 Stances on Fiscal Policy

1. Neutral: Government spending is completely covered by taxes.

2. Expansionary: Government spending is greater than tax revenue.

3. Contractionary: Government spending is lower than tax revenue.

Review:

1. What are the two tools of fiscal policy?

2. Who makes fiscal policy?

3. What fiscal policy actions would you take if unemployment was high and the US was in a recession?

4. What fiscal policy actions would you take if inflation rates were high?

Monetary Policy

Monetary policy is how the United States uses the Federal Reserve to stabilize the business cycle through controlling the money supply.

GOALS:1. Controlling inflation2. Fight

unemployment

“The Fed”

Federal Reserve System: -created 1913

- USA divided into 12 districts…each has a federal reserve bank

- all US banks belong to the system

“The Fed”

lend to member banks Set interest rates (the discount rate)

on what banks charge one another for loans

- consumer int. rates are “pegged” to that rate

Adjust money supplyin the economy.

Three Tools of Monetary Policy

1. Interest Rates2. Buy or Sell government bonds3. Reserve Requirement (ratio)

***Each of these tools is used to control the money supply!

Three Tools of Monetary Policy1. Interest Rate (Discount Rate) – The cost of borrowing money. (EX: Borrow $100 at 10% interest over one year. Pay back $110.

2. Government (Treasury Bonds) – IOUs issued by the Gov’t with a promise to pay back the amount over time plus interest.

Three Tools of Monetary Policy

3. Reserve Requirement (Ratio): A percentage set by the Fed that mandates how much of bank deposits must be kept in cash at the bank.

EX: Reserve Ratio is 10%. $100 is deposited by Alondra. How much must the bank keep on hand? How much can they lend out?

$10 must be held. $90 can be loaned out.

Controlling Inflation

How would the Fed control inflation (decrease the money supply)?

1. Raising the interest rates.2. Selling Government (Treasury) bonds.3. Raise the Reserve Ratio

Monetary Policy

How does the Fed control unemployment?

1. Lowers Interest Rate

2. Buy Gov’t Bonds 3. Lower the RR

Decreasing Unemployment:

How would the Fed decrease the unemployment rate (increase the

money supply)?:

1. Decreasing the interest rates.2. Buying Government bonds.3. Lower the Reserve Ratio

Review

Other than increasing interest rates, how might the Federal Reserve control inflation?

Answer: Selling gov’t bonds…this works by decreasing the amount of $ in the country b/c people will give their $ back to the gov’t in exchange for bonds.

Remember, bonds are simply I.O.Us …the gov’t is borrowing $ from you!

Review

1. Who creates Monetary Policy?

2. What are the two tools of Monetary Policy?

3. What Monetary Policy actions would you take to battle inflation?

4. What Monetary Policy actions would you take to reduce unemployment?

Monetary Policy

If prices are being pulled higher by increased demand (inflation!), one solution would be to lessen demand.

Any ideas how to discourage demand? How could the Fed make people less willing to spend??

Monetary Policy

Make it harder to borrow money to buy things on credit by making the cost of money more expensive. In other words…

RAISE INTEREST RATES!

If people are not buying products, the Fed will decrease interest rates…making it cheaper to borrow $.

Review1. Who creates Monetary Policy?

2. Who creates Fiscal Policy?

3. What are the two tools of monetary policy?

4. What are the two tools of fiscal policy?

5. What fiscal and monetary policy actions would you take if the country was in a recession?