Fiscal and Monetary Policies

The Government’s RoleIn the Economy

DRILL: What is the message the cartoonist is implying?

3 Goals of Economic Policy We have a mixed-market economic system Government’s role in the economy is to:

1. Promote steady growth (grow our economy)2. Keep people employed (full employment)3. Keep inflation low (price stability)

The Business Cycle:

The Business Cycle: Vocab! Peak: _________________________________ Trough: _______________________________ Expansion (Recovery):___________________________________________________________ Contraction: ___________________________________________________________________ Recession: ____________________________

ADD THESE:Economic Indicators GDP – Gross Domestic Product

• Measures how well the economy is doing• Total output (industry & services) of a country in

one year CPI – Consumer Price Index

• Measures inflation Unemployment Rate – unemployed ppl

• Measures the # of ppl who are out of work that want a full-time job

Fiscal Policy & Monetary Policy Congress and the President use taxes and

government spending to achieve economic growth, full employment, and stable prices

Federal Reserve uses reserve requirements, discount rate, and open market operations to achieve economic growth, price stability, and full employment

Fiscal Policy Congress and the President use taxes

and government spending to achieve economic growth, full employment, and stable prices

Expansionary & Contractionary Fiscal Policy Decrease taxes – people give less $ to the

gov’t, so:• People spend more $ and in stores• Items in stores are in more demand• Companies produce more• GDP will increase

Increase taxes – people give more $ to the gov’t, so:• People spend less $ in stores• Items in stores are in less demand• Companies produce less• GDP will decrease

Expansionary & Contractionary Fiscal Policy Increase gov’t spending – will create more

jobs, so:• People spend more $ and in stores• Items in stores are in more demand• Companies produce more• GDP will increase

Decrease gov’t spending – will create less jobs, so:• People spend less $ in stores• Items in stores are in less demand• Companies produce less• GDP will decrease

Advantages of Fiscal Policy Helps the gov’t achieve its economic

goals:• Growth (GDP)• Stability (Prices)• Full employment

Monetary Policy

Monetary Policy Federal Reserve uses reserve

requirements, discount rate, and open market operations to achieve economic growth, price stability, and full employment• Reserve requirements• Discount rate• Open market operations

The Federal Reserve It is the central bank of the United States It’s job is to balance between rapid growth

and recession• If money and credit grows too rapidly, inflation

can result• If money and credit grows too slowly, it can

cause a recession Uses three main tools:

• 1. Reserve Requirement• 2. Open Market Operations• 3. The Discount Rate (Interest Rates)

Reserve Requirement – the amount of $ banks must keep in their vaults

“Fed” decreases the reserve requirement, so:• Amount of $ the banks

can lend people goes up• Amount of $ in

circulation goes up• People spend more $

and in stores• Items in stores are in

more demand• Companies produce

more• GDP will increase

“Fed” increases the reserve requirement, so:• Amount of $ the banks can

lend people goes down• Amount of $ in circulation

goes down• People spend less $ in stores• Items in stores are in less

demand• Companies produce less• GDP will decrease

Discount Rate – the interest rate the “Fed” charges other banks

“Fed” decreases the discount rate – ordinary banks borrow more $ from the “Fed”, so:• Amount of $ the banks can

lend people goes up• Amount of $ in circulation

goes up• People spend more $ and

in stores• Items in stores are in more

demand• Companies produce more• GDP will increase

“Fed” increases the discount rate – ordinary banks borrow less $ from the “Fed”, so:• Amount of $ the ordinary bank can lend people goes down• Amount of $ in circulation goes down• People spend less $ in stores• Items in stores are in less demand• Companies produce less• GDP will decrease

Open Market Operations – people/businesses buy treasury bonds from the “Fed” “Fed” sells treasury bonds, causing

people/businesses to buy them, so:• Amount of $ in circulation goes down• People spend less $ in stores• Items in stores are in less demand• Companies produce less• GDP will decrease

“Fed” buys treasury bonds, causing people/businesses to sell them, so:• Amount of $ in circulation goes up• People spend more $ and in stores• Items in stores are in more demand• Companies produce more• GDP will increase

Advantages of Monetary Policy Helps the gov’t achieve its economic

goals:• Growth (GDP)• Stability (Prices)• Full employment