Monetary and Fiscal Policy

Current Events➲ Millions of Poor Are Left Uncovered by Health Law

● A sweeping national effort to extend health coverage to millions of Americans will leave out two-thirds of the poor blacks and single mothers and more than half of the low-wage workers who do not have insurance, the very kinds of people that the program was intended to help, according to an analysis of census data by The New York Times.Because they live in states largely controlled by Republicans that have declined to participate in a vast expansion of Medicaid, the medical insurance program for the poor, they are among the eight million Americans who are impoverished, uninsured and ineligible for help. The federal government will pay for the expansion through 2016 and no less than 90 percent of costs in later years.

● http://www.nytimes.com/interactive/2013/10/02/us/uninsured-americans-map.html?ref=health

➲ Poverty Should Have Risen By CASEY B. MULLIGAN

Current Events

➲ On Day 3 of Shutdown, Neither Side Budging in Budget Standoff

➲ Obama Sets Conditions for Talks: Pass Funding and Raise Debt Ceiling

➲ Opening Up the Fed (NYT 2/12) S. Johnson● The Federal Reserve has great power in modern

American society, including the ability to move the economy and, at least indirectly, to create or destroy fortunes. Its powers operate in two ways: through control over monetary policy, meaning interest rates and credit conditions more broadly, and through its influence over how the financial system is regulated generally and how specific large banks are treated.…during the 1980s the Fed’s board held 20 to 30 public meetings a year, but these dwindled during the Greenspan years to fewer than five a year in the 2000s and “only two public meetings since July 2010.” …meetings with opponents of reform outnumber meetings with supporters of reform about 10 to 1

What is ISLM economics?

➲ Discussed real sector of economy: production and income

➲ Discussed monetary sector➲ What policy tools do we have to affect

these?➲ Rough model. “Economics is a two-digit

science”➲ Idea is that economy is always moving

towards equilibrium

Equilibrium system or complex system with leverage points?

Chapter 7: Efficiency and Exchange Slide 6

Macroequilibrium in Real Sector

Conventional Goals of Monetary and Fiscal Policy

➲ Continual economic growth➲ Stable prices➲ ‘Full’ employment

Ecological Economic Goals?

➲ Ecological sustainability➲ Just distribution➲ Efficiency

● Max QOL/sustainable throughput, NOT monetary value of goods and services

Threats to growth

➲ Bubbles and Busts● Speculative investment

➲ Lack of investment● Which comes first?

➲ Financial instability hypothesis➲ Propensity to Save

● What has happened to US propensity to save?● In last 50 years? In last 4 years?

● Paradox of thrift➲ Biophysical limits➲ Social and psychological limits

Monetary Policy

➲ Based on supply and demand for money➲ Price of money = interest➲ Increase supply, price goes down, and vice

versa● Who controls money supply?

➲ Decrease interest, and more investments become lucrative

● Creates jobs, stimulates consumption● But what do people invest in?

➲ Decrease interest, and people buy more on credit, save less

● Creates demand for projects, stimulates investment

● Drives speculation

Monetary Policy

➲ Only affects market goods directly● Typically a trade-off between scale and

distribution● Poor at dealing with public goods, including

ecosystem services➲ Changing reserve requirements➲ Blunt instrument

Who’s in charge of MP?

➲ “The Federal Reserve, through its power to raise and lower interest rates, exercises more influence over economic growth and the level of employment than any other government entity. That unusual role dates from the 1970s, when the executive branch and Congress pulled back from the use of fiscal tools — vast New Deal spending and targeted tax cuts — as a means of regulating prosperity.” NYT 2009

Is this true? Real world

Fiscal conservatives?

Who Controls the Fed?

➲ The governors appointed by the president for 14 years, approved by Congress

➲ Chair appointed for 4 years➲ Regional bank presidents “selected by

leaders of their communities, particularly bankers.” (NYT)

Monetary Policy: 4 tools Fed can use:

● Reserve requirements (within bounds set by congress)

● Allows private banks to create more or less money● Interest rates (discount window)

● Rate at which Fed loans money to banks● Open market operations: buying and selling

government securities (bonds)● Changes money supply. ● Goal typically is to increase or decrease overnight interest

rates for banks loaning to one another (Fed funds rate)● Quantitative easing

● Buying governments bonds from gov’t● Buying toxic assets from private sector, corporate bonds● Could buy municipal bonds

What is the real goal of the Fed?➲ Officially to target unemployment and

inflation➲ “Their main thrust has been to limit inflation,

even at the risk of a recession”➲ NYT 2005, calling Bernanke a safe choice:

“The lessons of the Depression sometimes seem to hover behind much of his thinking. Shortly after becoming a Fed governor in 2002, for example, Mr. Bernanke argued forcefully for tough action to head off a possible epidemic of deflation, or downward spiraling prices.”

Why does Fed Target Inflation?

➲ “In settling on Mr. Bernanke, President Bush ... chose a candidate who would satisfy others -- investors on Wall Street, lawmakers in Congress -- more than himself or his Republican base.”

➲ ''They needed somebody that everybody, including the financial markets, would react positively to.''

➲ “But Mr. Bernanke had what many outsiders wanted: a world-class reputation among economists; credibility on Wall Street”

Why does Fed Target Inflation?

➲ NYT: To Senators, Bernanke Defends the Fed’s Dual Objectives

● Senate Republicans on Tuesday, like their colleagues in the House last week, expressed concern that the Fed effectively was declaring that it would prioritize job growth over inflation.

● “I want to disabuse any notion that there is a priority for maximum employment,” Mr. Bernanke responded.

Current Events

➲ Latest ‘Nobel’ laureates in econ➲ Debt default

Fighting Inflation

➲ Monetary policy● Raise interest rates: bad for debtors, good for

creditors, bad for farming, construction● Decrease money supply● Blunt instrument

➲ Either one can increase unemployment, reduce wages

➲ Feds 2 goals are at odds

Fighting Deflation

➲ Bernanke’s remedies● Buying treasury securities with longer maturities● Buy up private debt, e.g. corporate bonds● “In effect, the Federal Reserve would be printing

more money and injecting it into the economy — a strategy of “quantitative easing,” in Fed jargon.”

Limits to Monetary Policy

➲ Liquidity trap● When demand is inadequate, firms have excess

capacity, increasing money supply (reducing r) has no impact on investments.

● 'Pushing on a string’● Seems to be our current status

Current Monetary Policy

➲ Discount window from 5.75% August 2007 to ~0% today; Fed funds rate shows similar plunge

➲ “keep short-term interest rates near zero until late 2014”

Fiscal Policy

➲ Taxation● Reduces demand, contracts economy, drives

down interest rates➲ Government expenditure

● Stimulates investment, expands economy ● Drives up interest rates if competing with private

sector➲ Crowding out

● When economy is at full capacity, government expenditure might simply displace private sector expenditure

● This was dominant belief until recession● Allows macroallocation between market and

non-market resources

3 Ways for Government to Spend

➲ Tax and spend● Spending more than counteracts equal tax● Surplus = taxes > expenditures

➲ Borrow and spend● Greater short term impact than tax and spend● Deficit = expenditures > taxes● Borrowing now = taxes in future

➲ Print money and spend● Does not increase interest rates● Threat of inflation● We could increase reserve requirements,

give government more control

Current Fiscal Policy➲ Europe➲ US

Stimulus? Reagan vs. Obama

Reagan Obama

Gov’t employment

Up 3.1% Down 2.7%

Gov’t purchases goods and services

Up 11.6% Down 2.6%

Total gov’t spending, including transfers

Up >10% Up 2.6%

Or Austerity?

➲ Severe austerity in Europe➲ “Republicans swept to a majority in the

House on an antideficit platform” ➲ Goal now is deficit reduction

Quiz

➲ What impact should a monetary expansion have on interest rates and economic growth?

➲ What impact should an increase in the savings rate have on economic growth?

➲ What impact should a tax increase have on economic growth?

➲ What impact should an increase in government spending have on economic growth?

Impact of Policies on Scale, Distribution and Allocation

➲ What should our goals be?● Sustainable Scale● Just Distribution● Efficient allocation● Stability● How do we reduce consumption without

increasing unemployment, while making poor better off?

● What is appropriate balance between market goods and public goods?

Integrating Monetary and Fiscal Policy

From To

Fractional reserve banking 100% reserve requirements (window of opportunity)

Private sector seigniorage Public sector seigniorage

Growing money supply for growing economy

Constant money supply? for steady state economy

Pro-cyclical Countercyclical

New money spent on market goods

Taxing income and labor

New money spent on public goods or loaned for essential market goods

Taxing throughput and unearned income

Fiscal Policy to Regulate Gov’t Created Money Supply

➲ Spend and tax● Taxes destroy any money spent into existence.

Counter-cyclical expenditures must be accompanied by future tax increases.

● Tax things we don’t want➲ Lend and repay

● Government can lend money interest free for investment in public goods or critically important market goods

● Repayment destroys money● Money can be lent to state and municipal governments,

or used to purchase interest free bonds (monetizing state and local debt)

➲ Time deposits in local banks● The government can deposit money in local banks for

fixed periods of time, and the banks can then loan this money to customers. Withdrawal of the loan and payment of interest on the government portion of the loan both destroy the money created.

Taxes for a Sustainable and Just Economy

➲ Tax (or charge for) bads, not goods➲ Tax what we take, not what we make

● Capturing rent (unearned income)● What are current tax rates on unearned income?

➲ Taxation as a form of redistribution➲ Taxes to back money supply

Fiscal Policy

➲ Taxes● Can be targeted:

● 'tax bads, not goods’ ● 'tax what we take, not what we make’● Progressive taxes

● Reduces overall consumption● Stabilizes economy● Can have important impact on scale● WWII 96% marginal tax rate

Fiscal Policy

➲ Subsidies● Research and development● Activities that provide positive externalities:

'subsidize goods, not bads'

Fiscal Policy

➲ Government expenditures● Can be targeted: welfare for corporations or for

the poor?● Public goods or private goods? What offers

highest marginal benefits?● Investments in human made vs. natural K

➲ Crowding out in a full world● At full employment, gov’t expenditures on public

goods displace private expenditures