American Government and Politics Today

Chapter 16Economic Policy

Introduction– A major economic policy issue is how to

maintain stable economic growth without falling into either excessive unemployment or inflation (rising prices).

– Inflation, a sustained rise in the general price level of goods and services.

Good Times, Bad Times– The U.S. economy experiences booms and busts. The

busts are called recessions. • Recession, two or more successive quarters in which

the economy shrinks instead of grows.– Unemployment

• Full employment, an arbitrary level of (around 5%) unemployment that corresponds to “normal” friction in the labor market.

• Measuring Unemployment. US Department of Labor• Government Jobs Depression era Unemployment

Insurance– Inflation-A decline in the purchasing power of money over

time– The Business Cycle: reoccurring booms and busts

More than a Century of Unemployment

Changing Rates of Inflation: 1860-Present

National Business Activity, 1880-Present

Fiscal Policy– Fiscal policy is concerned with achieving economic policy goals

through changes in spending or levels of taxation. – Keynesian Economics

• Government Spending during slow times• Government Borrowing over Government Taxes

– Government should spend more than it receives, runs a deficit. Government makes up for both reduced spending and borrowing by consumers

• Discretionary Fiscal Policy-left to the policy maker to fine-tune the economy

• Discretionary Fiscal Policy Failures-LBJ failure to tax during a boom, borrowed instead and caused inflation. Nixon used price controls causing inflation

– The Thorny Problem of Timing-Agenda building…take time– Automatic Stabilizers-Tax system, unemployment insurance

Deficit Spending and the Public Debt– The government funds its deficit primarily by selling U.S.

treasury bonds. Twenty years ago, only 15 percent of these bonds were held abroad. Today the figure is 40 percent.

– The Public Debt in Perspective• Net public debt, the accumulation of all past federal

government deficits; the total amount owed by the federal government to individuals, businesses, and foreigners.

• Gross domestic product (GDP), the dollar value of all final goods and services produced in a one-year period.

– Are We Always in Debt? Keynsian economics advocates running budget surpluses during boom time. Clinton raised taxes and together with the dot.com boom. He presided over a budget surplus from 1998-2002. Then came 911.

Net Public Debt of the Federal Government

Net Public Debt as a Percentage of GDP

Monetary Policy– Monetary policy, the utilization of changes in the amount of

money in circulation to alter credit markets, employment, and the rate of inflation.

– Organization of the Federal Reserve System• 7 full-time members appointed by the president. Operate

12 banks with 25 branches to hold reserves. Federal open market Committee makes monetary policy decisions largely independently

– Loose and Tight Monetary Policies. The Fed implements policy by increasing or reducing the rate of growth of the money supply. The cost of borrowing money.

• Increasing the rate of growth is loose monetary policy. Cheap money. Fast economy.

• Reducing the rate is tight monetary policy. Expensive money. Slow economy.

Monetary Policy (cont.)

–Monetary policy has a problem with time lags, but the Fed can make a policy change more quickly than Congress.–The Fed announces changes to monetary policy by raising or lowering the federal funds rate, a government-controlled interest rate for funds that banks borrow from each other. –The Fed Tackles Inflation

• Volkernomics–Monetary Policy versus Fiscal Policy. If interest rates go high enough, people will stop borrowing and inflation will subside. Monetary policy cannot force people to borrow money in a recession. While monetary policy is more powerful against inflation, fiscal policy is more effective against recessions, because the government does the borrowing itself.

World Trade–Imports and Exports

• Imports, goods and services produced outside a country but sold within its borders.

• Exports, goods and services produced domestically for sale abroad.

–The Impact of Import Restrictions on Exports

• Protecting American Jobs• Quotas and Tariffs• Free Trade Areas and Common Markets

World Trade Keeps Growing

The World Trade Organization– The WTO seeks to lower trade barriers

worldwide. •What the WTO Does: The WTO also has a

dispute-resolution mechanism that nations may use.

– The WTO and Globalization. •The WTO has become the focus of those who

fear the supposed dangers of globalization. It is true that neither the United States nor any other country has a veto power within the WTO.

The Balance of Trade and the Current Account Balance

– The balance of trade, or the difference between the value of a nation’s exports of goods and its imports of goods. The U.S. balance of trade has been significantly negative for many years.

– The current account balance includes the balance of trade in services, unilateral transfers, and other items. It is also negative and has been growing more so.

– Are we borrowing too much from other countries?

The Current Account Deficit

Taxes as a Percentage of GDP in Major Industrialized Nations

The Politics of Taxes– Currently, Americans pay taxes that total to

somewhat less than 30 percent of the GDP.– Federal Income Tax Rates

•Loopholes and Lowered Taxes•Progressive and Regressive Taxation

– Who Pays? •Liberals tend to favor progressive taxes. •Conservatives either favor taxes that are less

progressive, or even flat or regressive.