Pearson-Longman copyright 2005 Economic Policy Chapter 19

Pearson-Longman copyright 2005

Economic PolicyChapter 19


Economic Growth and the Business Cycle

• Economies grow as the result of technological innovation, investments in physical capital and human capital.

• Gross Domestic Product (GDP) – The measure of the total value of

economic activity in a nation in one year.




• Recession– A slowdown in economic activity, officially defined as

a decline that persists for two quarters (six months).

• Business Cycle– The alternation of periods of economic growth with

periods of economic slowdown.

• Governments try to set economic policies that minimize disruptions caused by the business cycle. Avoid inflation and unemployment.



• Inflation– A sustained rise in the price level such that

people need more money to purchase the same amount of goods and services.

• Unemployment– The circumstance that exists when people who

are willing to work at the prevailing wage cannot get jobs.


Economic Conditions and Political Fortunes

• People tend to blame those in charge when times are hard.

• Often presidents will lose popularity when the economy falters.

• Very bad economic times are associated with massive election losses for the party of the president.

• Prosperity strengthens a president’s position in a reelection campaign and may help in congressional elections as well.



Fiscal Policy

• Fiscal policy: The sum total of government taxing and spending decisions, which determines the level of the deficit or surplus.– Deficit: The amount by which annual spending

exceeds revenue.– Surplus: The amount by which annual revenue

exceeds spending.


Use of the Budget Deficit

• Keynesianism– Economic policy based on the belief that

governments can control the economy by manipulating demand, running deficits to expand it, and surpluses to contract it.

– F.D.R. broke with traditional belief in a balanced budget and ran large deficits during the 1930s to get the country moving again.


Use of the Budget Deficit

• Council of Economic Advisors (CEA)– Three economists who head up a professional staff that

advises the president on economic policy.

– Established in 1946 by Congress

– CEA declined in importance in 1980s and 90s

– Presidents relied more on White House staffers, treasury secretaries, and other political aides.

– G.W. Bush has utilized the CEA.


Decline of Fiscal Policy

• Administrators less likely to use fiscal policy as a tool for managing the economy today.

• Why?– Divided government– Monetarism– Budget deficits– Internationalization


Monetary Policy: The Federal Reserve System

• Monetary Policy– The actions taken by government to vary the supply of money in

an effort to stabilize the business cycle.

– When supply of money increased, it is cheaper for private citizens and investors to borrow and spend more of it.

• Ex: interest rates decline and more economic growth

• If supply increases too quickly = inflation.

– If money supply is down, borrowing is more costly. Less to spend and invest so the economy slows.

• If supply less inflation will decrease, but if the economy contracts too quickly, result is likely to be unemployment.



Monetary Policy: The Federal Reserve System

• Federal Reserve System– The country’s central bank, which executes monetary policy by

manipulating the supply of funds that member banks can lend.

– Acts on the economy through the operations of its 12 regional banks.

– Open Market Committee• considers whether interest rates are too high or two low and what

adjustments should be made.

• Three primary tools: buy and sell federal securities, change the interest rate, change the percentage of deposits that banks are required to hold in reserve.


The Fed Chair

• The Fed is the second most powerful agency in Washington, D.C.

• Chair of the Federal Reserve Board ranks among the most powerful persons in government.– Close ties to the president

– direct access to economic information

– power to approve appointments of Fed Reserve Bank chairs


Who Controls the Fed?

• Relatively insulated from electoral pressure.• Congress has some influence.

– Created by congressional statutes.– Nominees to Fed Reserve Board must be approved by

the Senate.– Must make quarterly reports to banking committees in

House and Senate.– BUT, The Fed’s budget is not congressionally

determined. • Fed raises its own revenue. Hires its own staff.


Who Controls the Fed?

• Other influences include:– Banker dominance

– Presidential dominance

• Generally thought to be very independent.– Guaranteed by 14 year terms for board members.

– Only removed through impeachment process.

– Chair serves a 4 year term.

– More expert than political appointee.

– Generates confidence from business.


The “T” Word: Taxes

• Taxes are a much-debated topic in American politics.

• Debates centers on three important issues:– tax burden– the breadth of the tax base– progressivity of the tax structure



The Tax Burden

• Tax burden: The total amount of tax that a household pays.

• Federal individual income tax receipts (as % of GDP) rose by over 60% from 1950 to 1970).

• As long as living standards on rise, people willing to absorb higher taxes.

• Sizable budget surplus in late 1990s encouraged proposals for tax reductions.

• G.W. Bush - extensive tax cuts.


The Tax Base

• Tax Base– Types of activities, types of property, or kinds of

investments that are subject to taxation.

• Some argue more broad-based taxes are less intrusive.

• Tax Preferences– Special tax treatment received by certain activities,

property, or investments.

– Ex: tax credit for college tuition.


The Tax Base

• Tax preferences = classic slippery slope.– Once government grants them to one group, it

abandons the principle of neutral taxation.

– Granting preferences to some means that others must make up the shortfall.

– Sin taxes - when special tax treatment is unfavorable.• A tax intended to discourage unwanted behavior.

• Cigarettes and alcohol.


Tax Progressivity

• Progressive Tax– A tax structured so that higher-income people pay a

larger proportion of their income in taxes than do lower-income people.

– Ex: income tax

• Regressive Tax– A tax structured so that higher income people pay a

smaller proportion of their income in taxes than do lower-income people.

– Ex: payroll or social security tax


Tax Reform

• Flat tax– A tax that is neither progressive nor regressive;

everyone pays at the same rate.– Advocates of the flat tax argue that it is unfair

to require some people to pay a higher percentage of their income in taxes than others.

– More efficient; closes loopholes and need for professionals who work in tax preparation.


The U.S. Economy: An International Comparison

• When the Fed loosens or tightens the money supply, it is reacting to national and global economic forces.

• Sometimes, regardless of effort, it may be overcome.

• But where do we stand overall compared to other advanced democracies?


Taxes

• Tax burden in U.S. compares favorably with that in the world’s other developed countries.

• Among the lowest of the 13 major industrialized countries.

• Roughly 32% of GDP• Other countries pay more but provide more

services.• We rely more on income and payroll taxes. Other

countries rely more heavily on consumption taxes.



National Debt

• In 2004 the national debt was 7.5 trillion dollars.

• Size of the American economy at that time: 11 trillion dollars.

• Our debt considered moderate.

• As a proportion of GDP, France, Germany, and Canada all have national debts that are larger.



Employment Opportunities

• The United States has done a better job than most countries of incorporating new workers into the economy.

• Unemployment rate in 2003 for western Europe: 9 percent. U.S.: 5.9 percent.

• Some European countries required “guest workers” to return to their country of origin.

• U.S. allowed immigration to increase in the 1980s.

• “McJobs” or good jobs? Evidence suggests they are higher paying occupations.


Inequality

• Price of limited government seems to be greater social inequality.

• Compared to other advanced democracies, income inequality is the U.S. is higher.

• Emergent “class war”?

• But where is the popular demand to intervene?


Documents

Pearson-Longman copyright 2005 Economic Policy Chapter 19