Monetary Policy & Fiscal Policy

Putting Oomph in the C and I of the GDP

Monetary Policy -

What the Federal Reserve can do to “fix” the economy.

– Consumption and Investment

Works to keep monetary inflation under control

Fight demand – pull inflation with controlling the interest rates.

The Goals of the Federal Reserve

Regulating the money supply Serving as the government’s bank Supervising FDIC banks.

– Clearing checks– loans

The Money Supply: Types of Money

M1: Money that is readily made into cash or is cash.

M2: M1 + savings CDs, money markets, savings deposits.

M3 and L: M1 + M2 + large CDs, stort term treasury bonds and other“near money.”

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Monetary Policy and Aggregate Demand

Easy Money Policy

Low interest rates, makes money cheap. Increases C and I.

Tight Money Policy

Higher interest rates makes money expensive.

Decreases C and I.

Ben Bernanke’s Economic Tools

Open Market Operations.

Discount Rate Prime rate Reserve Requirements

            

Open Market Operations

If Bernanke wants to get more money into the economy he BUYS government bonds from banks. – Banks have more money to loan to customers.– People then have more money to consume and

invest.

Discount Rate

The interest rate that the Fed charges to banks. – The Fed raises the discount rate. The banks pass

the increase on to customers. Money is more expensive for customers as interest rates

go up. THE PRIME RATE.

Main Types of Interest Rates in 2009

Discount Rate– How much it costs to get money

from the Fed .5% (2009) 2.25% (2008)

Fed Funds Rate– How much money it costs to get

money from other banks. .25% (2009) 2% (2008)

Prime Rate– Best rate for best customers.

3.25% (2009) 5.0% (2008)

Reserve Requirement

Money that must be held by banks in their vaults or at the Fed. -Raise the reserve requirements on a bank. They

have LESS money to loan to customers. Less money is available – it makes the price of money (the interest rate) go up. SCARCITY. Makes C and I go down. -BUT THESE RESERVES ARE WHAT IS MEANT TO BACK UP FAILED BANKS!

Federal Reserve Problems?

Economic forecasting might not be quite correct.

Ben Bernanke’s priorities might not be the publics.

Lack of coordination with fiscal policies.

                 

Special Issues for banks in 2009

New powers for the Fed Chair

Stress Tests Bank Failures Getting credit going in

the marketplace again.

Did Bernanke realize things could go wrong in February 2008?

February – July 2008, the federal government granted Chairman Bernanke “extraordinary” powers that had once been Congress’ domain in the economy.

Bernanke’s new powers

The Federal Reserve should have a much larger role in supervising investment banks to prevent and limit financial market turmoil, Federal Reserve Chairman Ben Bernanke said, endorsing an expansion of the central bank's authority into new territory.

Bernanke’s Argument for the Fed Powers

"Holding the Fed more formally accountable for promoting financial stability makes sense only if the institution's powers are consistent with its responsibilities," Bernanke said.

Congress should consider giving the Fed power to set standards for capital liquidity holdings and risk management for investment banks, as it now does for commercial banks

October 2008

Bernanke talked to the President and Congressional leadership in a 45 minute private meeting.

October 2008 - Present

Chairman Bernanke and Secretary of the Treasury Geitner have extraordinary powers to intervene in the economy.

– Stimulus money injections– Regulation of banks /

corporations– Controlling of

corporations?

Stress Tests

Banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.

– DO THEY HAVE THE RESERVES TO SURVIVE?

Stress Tests

The average outlook of private-sector forecasters envisions the economy shrinking by 2 percent this year and unemployment peaking just below 9 percent in 2010.

The average forecast for housing prices is a decline of 14 percent this year and an additional 4 percent next year.

Economic Forecasting by the Fed?

Recent forecasts by the Federal Reserve and most private forecasters have undershot the severity of the downturn.

Bank Failures

29 so far in 2009! 57 failures (1998 – 2008) DOES THE FED HAVE

ENOUGH MONEY?

Fiscal Policy and the Economy

How does the President and Congress affect the economy?– Control of tax rate.

Proportional taxes (flat tax) – say 5% of everyone’s income whether you or Bill Gates.

Progressive taxes – Richer should pay more. Luxury taxes. Regressive taxes – Taxes the poor tend to pay more.

Lottery tickets, cigarette taxes.

Taxes

Majority of revenue for the US is through income tax. 45.2%

– Second is Social security taxes and contributions. 35%

– Third is corporate taxes. 11%

Recession

People have the money but don’t spend it.

Unemployment goes up. GDP slows.

Fiscal Cures for Recession

Change the tax rates.– Puts more money in the economy for Consumption

and Investment.

– Government Spending. Unemployment benefits, money for projects like roads, building improvements.

Problems of Fiscal Policies

Timing Problems. Might trigger inflation.

Political Pressures. Lack of coordination. Unpredictable economic

behaviors. – What worked in the past

might not work now.

            

Problem of Fiscal Policy in 2009: The Deficit

When government SPENDS (outlays) more than they TAKE IN (receipts) in taxes for the year – DEFICIT.

Projected 2009 deficit is -$490 Billion to 1.8 TRILLION.

Debt v. Deficit

In 2009 the government will spend somewhere between 490 billion to 1.8 trillion more than it takes in revenue. (DEFICIT)

US Debt is at http://www.brillig.com/debt_clock/– Or google US debt clock.

What is causing the deficit?

Higher government expenditures

– War in Iraq / Afghanistan– Government needs – Lack of taxes being

collected due to Recession Too many tax cuts in the

early 2000’s

Governments typically engage in deficit spending

Developed by economist John Maynard Keynes (1883 – 1946) to help get government out of the Great Depression (1930s)

Keynsian Economics

Fiscal Policy where it is more important to get the people of the country working.

Government goes into debt to employ people or give them benefits until they can find a job.

Keynsian Economics

IMPORTANT POINT!!! Okay to go into debt when

times are bad.– People are employed, they

begin to consume and invest again.

– Then government can collect taxes.

– WHEN TIMES ARE “GOOD” UP THE TAXES TO GET READY FOR THE NEXT “BAD” TIME.

US Government has not remembered that final rule of Keynsian Economics.

When times were good in the 1990s – taxes were cut.

Why be worried about the debt?

The interest we have to pay for the debt takes away from money we could spend on other things:

– Schools– Roads– Health care– Infrastructure

What should be the fiscal goals of government?

Stability- unemployment, inflation Equity - inequality, fairness Sustainability – resource use, balance Growth- per capita GDP, living

standard Flexibility – ability to change and adapt … : other needs of the society

The President’s Powers in Fiscal Policy

Budget proposals; program proposals

Veto power; may refuse to spend

Congress’ Powers in Fiscal Matters

May amend/ must approve budget

Propose programs Power of the purse

Govt. spending breaks down to two types:

Nondiscretionary / Mandatory. Taxing and spending programs enacted by a previous administration.

– TRANSFER PAYMENTS: Discretionary.

Programs making deliberate changes in taxes and spending.

GOALS OF FISCAL POLICY IN 2009?

Most fiscal policies are focused on Growth and Stability. Such policies aim for one of two general effects:

Increase output and employment– Contractionary– Expansionary

Expansionary Policy

Increase spending Increase transfer

payments Decrease taxes

Expansionary Goals

Reach Potential Output

Reach Full Employment

Control inflation Stimulate growth

Contractionary Goals

Reach Potential Output

Reach Full Employment

Control inflation Stimulate growth

Contractionary Policies

Decrease government spending

Decrease / Level transfer payments

Lower / Raise Taxes– More regressive taxing?