Transcript ECONOMIC POLICY

ECONOMIC POLICY
Chapter 18
O’Connor and Sabato
American Government:
Continuity and Change
Industrialization
• Following the Civil War, the US
moved from an agrarian to a
manufacturing based economy as the
US industrialized many large-scale
factories were created.
• This shift lead to many national
economic problems.
Industrialization
National problems such as…
– fluctuations between periods of economic
prosperity and economic downturn
– Industrial accidents
– Disease outbreaks
– Labor conflict
– Unemployment and the exploitation of workers
were too large and complex for state governments
alone.
Laissez-Faire Doctrine
• A French term meaning “to allow to do, to leave
alone.”
• It is a hands-off governmental policy that is
based on the belief that governmental regulation
of the economy is wrong.
• Essentially, what businesses thought of as
laissez-faire was an economic system and a set
of governmental policies that would be
supportive of the amassing of profits.
Economic Policy – Mr. Ruelas
• No Bell Ringer
• #5 in TOC – Economic Policy
Adam Smith’s Wealth of Nations
• The role of government should be limited to the
maintenance of order and justice, the conducts of
foreign affairs, and the provision of necessary
public works projects.
• Individuals should be left free to pursue their selfinterests.
• Competition and the laws of supply and demand
would control their behavior and ensure that selfinterests did not get out of hand. (um. no.)
Congressional Acts
• To control banking and regulate business, Congress passed three
acts:
• 1.The Federal Reserve Act (1913) created the Federal
Reserve System: The FRS regulates the national banking
system and to provide flexibility in the money supply.( more on
this to follow)
• 2. Establishment of the Federal Trade Commission (FTC): a
bipartisan body of five members appointed by the President for
seven year terms. This commission was authorized to issue
Cease and Desist (an order or request to halt an activity (cease)
and not to take it up again later (desist); or else face legal action.
The recipient of the cease-and-desist may be an individual or an
organization.
• 3.The Clayton Act (1914) prohibited unfair business practices
such as price discrimination, exclusive dealing contracts, and
corporate mergers that lessen competition.
The Great Depression / New Deal
• The Great Depression (a catastrophic worldwide economic
downturn) began with
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a stock market collapse
followed by rising unemployment
dropping prices
falling production
and financial panic.
• President Hoover announced that there was nothing wrong
and the economy was fundamentally sound. Panic ensued.
• FDR called for and Congress enacted a "New Deal" for
Americans. This legislation allowed for strong
government participation in the economy to relieve the
nation’s economic distress.
Financial Reforms of the New Deal
• Glass-Steagall Act (1933): required the separation of
commercial and investment banking and set up the Federal
Deposit Insurance Corporation (FDIC).
• Securities Act (1933): required that investors be given full
and accurate information about stocks and securities being
offered to them
• Securities Exchange Act (1934): created the Securities
Exchange Commission (SEC) which regulated the stock
exchange, enforced the Securities Act, and reduce the
number of stocks bought on margin.
• Buying on margin: to borrow money to purchase stocks
Labor Reforms
• National Labor Relations Act of 1935 (Wagner Act)
– Guaranteed worker’s rights to organize and bargain
collectively through unions of their own choosing
• National Labor Relations Board
– Created to carry out the act and to conduct elections to
determine which union, if any, employees wanted to
represent them.
• Fair Labor Standards Act (1938)
– Intended to protect the interests of low-paid workers, the law
set 25 cents per hour and 44 hours per week as initial
minimum standards.
Legacy of the New Deal Era
• Passive government was
replaced by active government.
• The Federal government
became the primary source of
solutions for economic
problems.
• People look to the
government to establish
fiscal and monetary
policies that keep the
economy moving forward.
Today’s Minimum Wage
• What is CA's minimum wage? The California minimum
wage of $9.00 per hour is the lowest amount a non-exempt
employee in California can legally be paid for hourly
work.
• How much does a minimum wage worker in California
earn per year? A full time minimum wage worker in
California working 40 hours a week, 52 weeks a year, will
earn $360.00 per week, or $18,720.00 per year1.
• This does not include federal state taxes
• The national poverty line for a family unit consisting of
two people is $16,570/year.
• The price of a gallon of gasoline is about half the hourly
minimum wage.
• https://www.youtube.com/watch?v=slFZ8K2aBoY
What is Economics?
• What Does Macroeconomics Mean?
Macroeconomics examines economy-wide phenomena such as
changes in unemployment, national income, rate of growth, gross
domestic product, inflation and price levels.
• What Does Microeconomics mean? The branch of economics that
analyzes the market behavior of individual consumers and firms in
an attempt to understand the decision-making process of firms and
households. It is concerned with the interaction between individual
buyers and sellers and the factors that influence the choices made
by buyers and sellers.
• In particular, microeconomics focuses on patterns of supply and
demand and the determination of price and output in individual
markets (e.g. coffee industry).
Economic Terms to Know
• Economic stability: a situation in which there is economic
growth, rising national income, high employment, and steadiness
in the general level of prices
• Inflation: A rise in the general price levels of an economy. Your
money is worth less because a dollar buys you less.
• Recession: A decline in the economy that occurs as investment
sags, production is decreased, and unemployment increases.
• Monetary Policy: government policies and practices that control
the nation’s money supply and interest rates to maintain the
economy.
• Fiscal Policy: government policies and practices on taxes,
spending, debt management that influence the economy
How Does the Government Control
the Economy?
• The US government primarily uses
two instruments to affect the
economy…
– Monetary policy
– Fiscal policy
Basic Premise of Monetary Policy
• Monetary policy is the way the Federal Reserve
controls the money supply via interest rates.
• The lower the interest rates the more people will
borrow.
• The more people borrow the more they will spend.
• The more people spend the stronger the economic
growth.
• The opposite is also true.
Monetary Policy
• Monetary policy involves the regulation of the country's
money supply and interest rates.
• The primary responsibility for monetary policy rests with
the Federal Reserve Board (Feds).
• The Federal Reserve System was created in 1913 consists
of:
– Federal Reserve Board: a seven-member board that sets
member banks’ reserve requirements, controls the
discount rate, and controls credit available
– the Federal Open Market Committee
– 12 Federal Reserve Banks
The Federal Reserve System
• The Fed regulates and manages the money
supply in accordance with the levels of output,
employment, and prices.
• The Fed has three tools at its disposal:
1. Open Market Operations
2. Reserve Ratio
3. Discount Rate
1. Open Market Operations
• The Fed buys and sells government securities (stocks and
bonds) to commercial banks and to the general public.
• The buying of bonds increases the money supply by
putting dollars into circulation.
• The selling of bonds decreases the money supply by
removing dollars from circulation.
• This is the primary tool used by the Fed to alter and
regulate the money supply.
What are Bonds?
• Companies and governments issue bonds to fund their dayto-day operations or to finance specific projects. When you
buy a bond, you are loaning your money for a certain
period of time to the issuer, be it General Electric or Uncle
Sam.
• In exchange, the borrower promises to pay you interest
every year and to return your principal at "maturity," when
the loan comes due, or at "call" if the bond is of the type
that can be called earlier than its maturity (more on this
later). The length of time to maturity is called the "term."
2. Reserve Ratio
• This is the mandated percentage of deposits that banks are
required to keep.
• If the Fed increases the reserve ratio, it reduces the money
supply by increasing the amount of cash that a bank has to
keep in its vault
( required reserves).
• By increasing the required reserves for banks, the Fed
decreases the amount of the bank’s excess reserves and,
hence, the amount of money that banks have to loan.
• If the Fed reduces the reserve ratio, it increases the money
supply by decreasing the amount of required reserves and,
hence, increasing the amount of excess reserves and
loanable funds.
3. Discount Rate
• This is the interest rate that the Fed charges on money
loaned to commercial banks.
• Many short-term interest rates are tied to the discount rate.
• If the Fed increases the discount rate, it decreases the
money supply by decreasing borrowing (increases interest
rates).
• If the Fed decreases the discount rate, it increases the
money supply by stimulating borrowing (decreased interest
rates).
• Altering the discount rate is often used to send a signal to
financial markets as to the type of monetary policy the fed
is undertaking.
Expansionary Monetary Policy
• Policies to increase the money supply are used
when growth in the economy is too slow or
stagnant. Specifically, the economy is faced with
high unemployment and deflation.
• To increase the money supply the Fed would:
Buy securities
Reduce the reserve ratio
Lower the discount rate
• This would stimulate investment which leads to
firm production and employment.
Contractionary Monetary Policy
• Policies to decrease the money supply are used when
growth in the economy is too fast. That is, the economy is
faced with cost-push inflation created by labor shortages.
• Cost-push inflation is when a shortage of supply of labor,
raw materials or capital drives up prices. The demand
remains the same, but since there are fewer goods or
services, the supplier can charge more per unit.
• To decrease the money supply the Fed would;
Sell securities
Increase the reserve ratio
Raise the discount rate
• This is used to decrease investment and slow economic
expansion.
The Federal Reserve Districts
The Federal Reserve System
• The Federal Reserve is the central bank of the
United States.
• Its unique structure includes a federal government
agency, the Board of Governors, in Washington,
D.C., and
• 12 regional Reserve Banks operating 25 branches.
• http://youtu.be/y1OJlJ9COg0
Chairperson Janet Yellen
• Janet Yellen began her
term on February 1, 2014.
• She is the first woman to
hold this position.
• There have only been 15
Chairpersons of the
Federal Reserve Board.
• The Chair is the "active
executive officer"[2] of the
Board of Governors of the
Federal Reserve System
Retail Banks
• A retail bank is a bank that works with consumers,
otherwise known as 'retail customers'. Retail banks provide
basic banking services to the general public, including:
• Checking and savings accounts
• CDs
• Safe deposit boxes
• Mortgages and second mortgages
• Auto loans
• Unsecured and revolving loans such as credit cards
Commercial Banks
• A commercial bank is a bank that works with
businesses. Commercial banks handle banking
needs for large and small businesses, including:
• Basic accounts such as savings and checking
• Lending money for real and capital purchases
• Lines of credit
• Letters of credit
• Lockbox services
• Payment and transaction processing (settlement)
Investment Banks
• Investment banks help organizations use
investment markets. For example, when a
company wants to raise money by issuing stocks
or bonds, an investment bank helps them through
the process.
• Investment banks also consult on mergers and
acquisitions, among other things.
• Investment banks primarily work in the
investment markets and do not take customer
deposits. However, some large investment banks
also serve as commercial banks or retail banks.
The Stock Market
• Basically the stock market is a place where you can buy and sell shares
in a company.
• When a company makes shares available for the public to buy they are
called stocks and this is what you are trading.
• In most cases what you get when you buy a stock is a very small piece
of the company. You are an owner of that company and as it grows the
company should become more valuable which means that your stocks
should become more valuable as well.
• Since the goal of investors is to get the maximum return on their
investment the goal is to buy the stock before the price goes up and
then to sell it before it goes back down.
• This means that you have to pay attention to what the value of the
company you are buying stock in will be in the future.
Stock Market Continued
• This is why you often see the price of the stock go up before an
earnings announcement and then decline even if the earnings were
higher than expected. People bought the stock in the expectation of
good earnings which drove the price up and then sold when the good
earnings were announced since it was likely that the stocks value had
peaked, at least temporarily.
• One thing that confuses a lot of people when the invest in the stock
market is that they don't receive any of the company's profits. In a few
cases you will, mainly with large well established companies, this is
called the dividend which is paid on a per share basis.
• However with most companies they will retain the profits to help pay
for future growth. Most investors are more interested in growth than in
receiving dividends.
• There is a school of thought that you should invest in companies that
pay dividends.
• http://youtu.be/ejjNMnIo3Fg
Futures Contracts
• A contractual agreement, generally made on the trading
floor of a futures exchange, to buy or sell a
particular commodity or financial instrument at a predetermined price in the future.
• This is done to avoid price volatility.
• Futures contracts detail the quality and quantity of the
underlying asset; they are standardized to facilitate trading
on a futures exchange.
• This transfers the risks and rewards to the investor.
• Some futures contracts may call for physical delivery of
the asset, while others are settled in cash
• http://www.investopedia.com/video/play/futures-contractexplained
Securities
• A document; historically, a physical certificate but
increasingly electronic, showing that one owns a portion of
a publicly-traded company or is owed a portion of a debt
issue.
• Securities are tradable in the securities market.
• At their most basic, securities refer to stocks and bonds,
but the term sometimes also refers to derivatives such as
futures and options.
• Government securities include Treasury Bonds and Bills.
• All government securities are regulated by FINRA
( Financial Industry Regulatory Authority)
• http://youtu.be/MfvCXmUsOa8
Derivatives
• A derivative is a financial instrument that gets its
value from an authentic good or stock.
• It is, in its most basic form, simply a contract
between two parties to exchange value based on
the action of a real good or service.
• Typically, the seller receives money in exchange
for an agreement to purchase or sell some good or
service at some specified future date.
• http://youtu.be/m3im-iJdhv4
• Show Clip from Capitalism: A Love Story
Mutual Funds
• A mutual fund is nothing more than a collection of stocks and/or bonds.
You can think of a mutual fund as a company that brings together a group of
people and invests their money in stocks, bonds, and other securities.
• Each investor owns shares, which represent a portion of the holdings of the
fund.
You can make money from a mutual fund in three ways:
1) Income is earned from dividends on stocks and interest on bonds. A fund
pays out nearly all of the income it receives over the year to fund owners in
the form of a distribution.
2) If the fund sells securities that have increased in price, the fund has a
capital gain. Most funds also pass on these gains to investors in a
distribution.
3) If fund holdings increase in price but are not sold by the fund manager,
the fund's shares increase in price. You can then sell your mutual fund
shares for a profit.
• http://youtu.be/TPS22HRRY1k
Funds will also usually give you a choice either to receive a check for
distributions or to reinvest the earnings and get more shares.
The President and the Federal
Reserve Board
• Although the public holds the president responsible for
maintaining a healthy economy, he does not possess adequate
constitutional or legal authority to do this.
• The President shares this responsibility with Congress.
• Congress authorizes the FRB to make monetary policy.
• At best, the President has the “power to persuade” the FRB to
adjust monetary policy (adjust interest rate)
• During formal meetings, the chairperson of the FRB conveys his
views on the economy to the administration.
• The president customarily accepts the monetary policy made by
the FRB.
th
16
Amendment
• The Sixteenth Amendment (Amendment
XVI) to the United States Constitution
allows the Congress to levy an income tax
without apportioning it among the states or
basing it on Census results.
• Income tax is how the government funds
programs and services.
Taxation
• Progressive tax (aka graduated income tax): tax in
which the average tax rate increases as the amount subject
to taxation increases.
• Regressive tax: a tax imposed in such a manner that the
tax rate decreases as the amount subject to taxation
increases
• Flat tax: a system of taxation where one tax rate is applied
to all income with no deductions or exemptions.
• A proportional tax is a tax imposed so that the tax rate is
fixed. The amount of the tax is in proportion to the amount
subject to taxation
• The taxation of people is part of fiscal policy.
• Ways and Means Committee initiates tax policy.
Fiscal Policy
• Fiscal Policy is defined as: the deliberate use of the
national government’s taxing and spending policies to
influence the overall operation of the economy and
maintain economic stability.
• Intention of Fiscal Policy: promote the nation’s
macroeconomic goals, particularly with respect to
employment, price stability, and growth.
• The President and Congress formulate fiscal policy and
conduct it through the federal budget process.
• We just saw how the President and Congress struggle to
agree on the federal budget. (power of the purse)
• Tax policy is done by the Ways and Means Committee.
Fiscal Policy
• Following the economist John Maynard Keynes,
government spending has been used to offset a
decline in private spending and help maintain
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levels of spending
production
employment.
Argued that deficit spending by a government could
supplement the total demand for good and services.
• Fiscal policy involves taxation and government
spending policies to influence the overall
operation of the economy.
Deficit Spending
• Deficit spending is the
amount by which a
government, private
company, or individual's
spending exceeds income
over a particular period of
time, also called simply
"deficit," or "budget
deficit," the opposite of
budget surplus.
• Many economists argue
over the issue of deficit
spending and whether it is
sound economic practice.
Deficit Controversy
• Mainstream economists feel that deficit spending is desirable
and necessary as a part of fiscal policy.
• In an economic slump (recession), government should run
deficits to compensate for the shortfall in aggregate demand, but
should run corresponding surpluses in boom times so that there
is no net deficit over an economic cycle – a cyclical deficit.
• Aggregate demand is the total demand for final goods and
services in the economy (Y) at a given time and price level.
• This is derived from Keynesian economics .
• Fiscal conservatives reject Keynesianism and, in the strongest
form, argue that government should always run a balanced
budget (and a surplus to pay down any outstanding debt), and
that deficit spending is always bad policy.
Other Arguments Against Deficits
• The usual argument against deficit spending is that
households should not run deficits – one should
have money before one spends it, from prudence –
and that what is correct for a household is correct
for a nation and its government.
• A further argument is that debts must be repaid,
and thus it is burdening future generations to run
deficits today, for little or no gain.
Deficit vs. Debt
• Suppose you spend more money this month than your income.
This situation is called a "budget deficit". So you borrow (ie;
use your credit card).
• The amount you borrowed (and now owe) is called your debt.
You have to pay interest on your debt.
• If next month you spend more than your income, another
deficit, you must borrow some more, and you'll still have to pay
the interest on your debt (now larger).
• If you have a deficit every month, you keep borrowing and your
debt grows.
• Soon the interest payment on your loan is bigger than any other
item in your budget.
• Eventually, all you can do is pay the interest payment, and you
don't have any money left over for anything else. This situation
is known as bankruptcy.
• Debt= Accumulative Deficits
Google drive: Deficit and Debt Video
Congress and the Budget
• Budget and Accounting Act of 1921
– Gave the president authority to prepare an
annual budget and submit it to Congress
• Staff agency now called the Office of
Management and Budget was created to assist the
president in this process.
• President sends budget proposal to Congress in
January or February of each year.
• Congress and the appropriations committees
actually provide the funding needed to carry out
programs (power of the purse).
The Budget Process
• POTUS writes the budget with the help of the Office of
Management and Budget (OMB) by the first Monday of
February.
• The budget is sent to Congress for approval.
• Congress utilized the services of the Congressional Budget
Office (CBO) to give recommendations and/or concerns.
• POTUS either approves the recommendation or alters and
resubmits the budget to Congress.
• Executive version and Legislative version must be the
same. This is due by April 15th.
• The fiscal year begins October 1st and ends last day of
September.
• http://youtu.be/EhUTz4KUl8M
• https://youtu.be/fWu8o-ZzUNs
Budget and Impound Control Act of 1974
• Congress established this act to give itself more
control over the budget process.
• The process includes:
• setting overall levels of revenues and
expenditures
• Size of the budget surplus or deficit (debt
ceiling)
• Prioritizing among different functional areas
including defense, foreign aid, transportation,
etc.
The Federal Budget Process
Purpose of the Budget
• Purpose: fund government programs and services.
• The federal budget planning begins roughly one and a
half years before the fiscal year it is to take affect.
• Once a budget is adopted, it takes time to implement
the provisions.
• The budget is not a precise instrument for manipulating
the economy.
• The process is complex, disjointed, and political.
Raising and Spending Money
• The federal government raises the most money
from individual income taxes and social insurance
and retirement receipts (this includes Social
security, hospital insurance, and other taxes).
• Most government spending is directed towards
National Defense and Human Resources.
• Human resources includes health, income security,
and social security.
Deficit and the Budget
• Show the clips from AP Institute google
docs.
Deficit and the Budget
Showdown on the Budget
U.S. Debt Crisis
• US Budget a visual perspective
https://youtu.be/R6GtsXv0VtY
TAXES and SPENDING
Income Security Programs
• ISP’s protect people against loss of income due to
retirement, disability, unemployment, death, or
absence of the family breadwinner.
• ISP’s have two categories: non-means based and
means-tested.
• Non-means: provide cash assistance to qualified
beneficiaries.
• Means-tested: people must have incomes below
specified levels to be eligible for benefits.
Social Insurance Programs
The Effectiveness of Income
Security Programs
• Entitlement programs
– Income security programs to which all those meeting
eligibility criteria are entitled.
– Spending for such programs is mandatory.
• Funds must be provided for them unless laws creating
the programs are changed.
• Difficult to control spending for this reason.
• Often a matter of considerable debate.
• Range of such programs are characteristic of all
democratic industrial societies.
Entitlement Programs
• Income security program to which all those
meeting eligibility requirements are entitled.
• Examples include social security, food
stamps, unemployment benefits, school
breakfast or lunch program, and Woman
Infant Children coupons (WIC).
• Spending for entitlement programs is
mandatory
More Examples of Entitlement
• The most important examples of entitlement
programs at the federal level in the United
States would include Social Security,
Medicare, and Medicaid, most Veterans'
Administration programs, federal employee
and military retirement plans,
unemployment compensation, food stamps,
and agricultural price support programs.
Discretionary Spending
• Discretionary spending is a spending category
through which governments can spend through an
appropriations act.
• This spending is optional as part of fiscal policy,
in contrast to entitlement programs for which
funding is mandatory.
• Discretionary spending can be increased or
decreased as part of the annual budget approval
process.
Automatic Stabilizers
• Designed to operate without decisions by policymakers
• Act as buffers when the economy weakens by
automatically reducing taxes and increasing government
spending
• When the economy declines, mandatory spending for such
programs as unemployment insurance, food stamps, and
Medicaid INCREASES because eligibility benefits
depends on people’s income or unemployment status.
• In a slower economy, since people and corporations have
less money, tax payments fall and help reduce the decline
in after-tax incomes.
• Although automatic stabilizers are helpful in mitigating
economic fluctuations, they are by themselves inadequate
to stabilize, control, and maintain the economy.
Entitlements and Discretionary
Spending 1963-2007
Gross Domestic Product
• The GDP is the total market value of all goods and services
produced in a country during a year.
• Budget deficit: The amount by which a government’s spending
exceeds its income over a particular period of time. (aka deficit
spending)
• Budget deficits are expressed as a percentage of the GDP.
• Yearly deficits increased national debt.
• During the 1980’s the national debt tripled from $909 billion to
over $2.87 trillion in 1989.
• By 1996 the national debt was nearly $5 trillion.
• The national debt increases an average of $4.09 billion per day!
• The current national debt (May 2014) is over $17 trillion. Yikes
• http://www.brillig.com/debt_clock/
Causes of Rising National Debt
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Post 9/11 policies and programs
Multiple Wars and military conflicts
Increase in military spending
Government bailouts to corporations
Inadequate corporate taxation policies
Tax exemptions for the wealthiest
Federal loan assistance programs
Growth in Human Resource Spending
Federal spending in recovery and assistance in national and
international natural disasters.