Lecture Notes:

LECTURE OUTLINEI. What If . . . There Were No Social Security?A. This feature presents a scenario in which students are asked to consider the possibility

of Congress eliminating the Social Security program for younger workers.B. The outcome of such a proposal would depend largely on whether Congress would

eliminate the payroll tax it currently requires American workers to pay. If it did, this would mean that many Americans could use the additional 16 percent of their incomes to invest privately for their retirements.

C. Such a scenario might prove problematic when those younger workers without Social Security retire. While some will have saved adequately for their retirement, others will not have, or will have made risky investment choices and thus have inadequate resources for their retirement.

D. In addition, eliminating Social Security would necessarily mean the elimination of Medicare, wince Medicare is funded with Social Security taxes. This would mean that individuals, in addition to providing for the own retirements, would have to pay for private health insurance throughout their retirement years.

II. The Policy-Making ProcessA. The first step in the policy-making process is identifying a problem. Numerous

problems exist, but their solutions are impossible until they are identified by policymakers as problems. Typically this occurs through public debate. Policymakers also rely on their constituents, friends, interest groups and the media to bring policy problems to their attention.

B. The identification of a problem, the reaction to the problem and the solution all form the policy process. There are five key steps in this process.

1. Agenda Building - This is the effort of identifying a problem and getting it on the agenda. This may come about through crisis, or through the lobbying efforts of interest groups or other concerned about the problem.

2. Policy Formulation - This consists of the debate that occurs among government officials and the public in the media, in Congress and through campaigns.

3. Policy Adoption - This is the selection of a strategy for addressing the problem from among the solutions discussed.

4. Policy Implementation - This is the administration of the policy adopted by bureaucrats, the courts and others.

5. Policy Evaluation - Groups evaluate the policy to determine if it has had the desired impact. The feedback also evaluates unintended consequences of the policy adoption. The feedback is considered part of the agenda building and formulation process, so that policy can be “fixed” if needed.

III. Poverty and WelfareA. To define poverty, the government devised a system which defined poverty based on

a families income in comparison to the cost of a nutritious food plan. All families whose income level was not at least a three times larger than the food plan were classified as below the poverty line. Since 1969 when this initial calculation was made, the government has revised the formula based on changes in the consumer price index (CPI). In an attempt to assist these families, the government made transfer payments to them in the form of programs like food stamps and housing

vouchers. How effective these programs have been is hard to establish because of dramatic changes that have taken place within society.

B. Because of societal changes there have been new groups that have added significant numbers to the classification of people below the poverty level. Single-parent family incomes are significantly less today in comparison to the 1960s. Furthermore, the number of single-parent families has grown dramatically and this trend shows no signs of abating. Nineteen percent of all children in America live in poverty and children are 50 percent more likely than the rest of the population to be in poverty.

C. In an effort to resolve some of the most pressing problems of poverty, the federal government has established the following programs:

1. Social Security provides monthly payment to people who are retired or unable to work. This program was initiated in the 1930s to assist the elderly in society. Since the inception of this program numerous changes have been made to provide more service to a wider array of individuals within the society.

2. Supplemental Security Income (SSI) was established to provide a minimum income for the aged, the blind, and the disabled.

3. Food Stamps are designed to provide adequate nutrition for families who cannot afford to purchase necessary food items. The program began as a twofold mission to help farmers to sell surplus products and to eliminate malnutrition.

4. Aid to Families with Dependent Children (AFDC) provided aid to children in poverty who do not have two parents. This program was administered by state governments but was financed by the federal government. This program was eliminated by the Welfare Reform Act of 1996 and replaced with TANF.

5. Temporary Assistance to Needy Families (TANF) is a state-administered program in which grants from the federal government are used to provide assistance to those qualified to receive welfare benefits.

6. The Earned Income Tax Credit (EITC) helps lower-income workers by providing a rebate on Social Security taxes paid to federal government. A criticism of the EITC is that it has been disproportionately by part-time workers. Also, other critics contend that it has done little to reduce the poverty rate.

D. The Welfare Reform Act of 1996 had several key components. Importantly it provided for devolution of the welfare system, where the states receive federal funds to address a problem that previously had been under the purview of the federal government. The Act incorporated one major change -- most welfare recipients are now limited to two years of assistance at one time, with a lifetime limit of five years. The Act also provided incentives, in the form of “bonus payments,” to states that reduce their rate of illegitimate births. The Act also allowed the states to deny benefits to unmarried -teenage mothers.

E. The policies aimed at solving the problems of poverty and homelessness have been controversial. Some programs have worked as intended while others have not succeeded in accomplishing some the intended goals. Critics of the programs contend the policies do not encourage people to remove themselves from poverty. There is, according to some, an incentive to remain in poverty to avoid work. Other critics point out that these programs have penalized people who are married. These critics claim individuals will not get married in order to continue to receive benefits

from the government. Most recipients, as well as proponents of these programs, deny that the people in poverty want to remain in poverty.

F. The problem of homelessness continues to be an important one, and many advocates for the homeless argue that the Welfare Reform Act has exacerbated the problem. Estimates are that on any given night there are anywhere from 230,000 to 750,000 people who are homeless. The fastest growing sub-group of the homeless are families. The debate surrounding the policy issue of homelessness is couched in ideological terms, as are the solutions to this problem.

IV. Crime in the Twenty-First CenturyA. Crime has always been considered a problem in American society. On the one hand,

the public demands protection from criminals, but on the other, fair treatment from the law enforcement officials. On numerous occasions these two desires come into conflict. Law enforcement officials have been criticized from both extremes. When violent crimes increase, the public demands the police take strong action to stop such actions. When the police take actions to reduce violent crimes, they are often accused of violating the rights of innocent people.

B. The cost for public safety from violent crimes is enormous. In most states the cost to incarcerate an inmate is five times the amount spent to educate a child for a single year. As prison populations increase so to will the cost to the taxpayers.

C. One of the major causes of crime in the U.S. is illegal drugs. Illegal drugs cause crime because they result in turf wars between rival drug gangs, because they operate outside the justice system and therefore resort to violence to settle disputes and because drug addicts resort to crime to finance their drug habit. Money spent on federal drug interdiction programs had not met with much success, as illegal drug consumption in the U.S. has remained steady. State and local governments, however, have been attempting new remedies to curtail the drug problem. One strategy includes sentencing drug offenders to rehabilitation, rather than prison.

D. Probably the most devastating type of crime is terrorism because of its ability to inflict violence on thousands of victims. After the attacks of September 11, 2001, the federal government enacted many policies in an effort to combat terrorism, including the war or terrorism. Some policies enjoyed widespread public support, others did not. What seems clear, however, is that counter-terrorism strategies will necessarily be a part of federal government policy for years to come.

V. Environmental PolicyA. The public had a growing awareness of environmental problems throughout the 1970s

and 1980s. Major environmental problems like oil spills and toxic waste sites have led the government to formulate long-term policy aimed at protecting the environment without causing major damage to the economy. The following polices reflect the concern the government has for the need to protect the environment.

1. The National Environmental Policy Act was enacted in 1969 in an attempt to set national standards for assessing the impact that major federal projects (construction of roads, buildings, etc.) would have on the environment. Such projects could not be started without first receiving an environmental impact statement (EIS).

2. The 1990 amendments to the Clean Air Act of 1963 constitute a comprehensive policy mandating cleaner air in urban areas. Utility plants emission levels are monitored and they must significantly reduce the amount of carbon monoxide

emissions. Automobile manufacturers must reduce emissions of nitrogen oxide must progressively until 2007.

3. The Clean water Act of 1972 amended the Federal Water Pollution Control Act of 1948. The Clean Water Act sought to make waters safe for swimming, protect fish and wildlife, and eliminate discharge pollutants into the water. The Clean Water Act has proven controversial, however, because of its broad definition of “wetlands” (which are subject to prohibitions on filling and dredging) and because of the “migratory bird rule” (which ruled any waters suitable for use by migratory birds were subject to regulation as wetlands).

B. Critics of our environmental policy contend that these restrictions cost jobs and negatively affect the economy. Without doubt, there are substantial costs involved in the new policies. But there are also substantial costs involved in not attempting to resolve the environmental problems.

VI. The Politics of Economic Decision MakingA. Typically, in dealing with economic decisions, policy makers are asked to make

policy trade-offs. For example, the cost associated with shoring up Social Security and Medicare by using the budget surplus means that policy makers would not be able to use that money for a tax cut.

B. Taxes are a method used to raise revenue for the government. Subsidies are a method used by the government to assist producers of a certain commodity. The questions concerning both taxes and subsidies are related to who shall pay and who shall receive. Action reaction syndrome states, “For every action on the part of the government, there will be a reaction on the part of the public.”

C. The income tax code prior to 1986 was very complex and difficult to understand for the average citizen. While the tax was in theory a progressive tax, there were numerous loopholes that allowed high-income earners to avoid the high tax rates. The 1986 Tax Reform Act made major revisions in the tax rates and attempted to eliminate many of the so-called loopholes. Since the 1986 revisions various groups have lobbied Congress to make significant alterations in the tax code. Many of the recommendations by these groups have been enacted and because of these alterations the tax policy is once again becoming complex.

D. Social Security was established in 1935 with the intent of providing a type of insurance for a large segment of the public. Employees and their employers pay a tax on a percentage of the employees’ wages. However, unlike private insurance programs where the individual insured makes payments in to a account for his or her own policy, the money paid into the Social Security program is used to provide benefits for people who have already retired, or who are qualified to receive funds. Initially for every recipient of Social Security there were forty workers paying into the general fund- a 1 to 40 ratio. Had the ratio of recipients to workers remained the same, there would have been few problems concerning Social Security.

E. Social Security depends upon the taxes paid by workers, which are used to purchase bonds from the U.S. Treasury. Today, more money is paid in to Social Security than is taken out. But this will not be the case when the baby boomers retire. This will mean that some of the bonds will have to be sold. If no action is taken to correct this imbalance, then eventually (some estimates say around 2030) all of the bonds will be

sold. This would mean that any benefits paid would have to come out of current-day taxes.

F. Two major problems confront Social Security: 1) the ratio of recipients of Social Security to workers has decreased dramatically; and 2) the life expectancy for Americans has steadily increased and apparently will continue to increase. These two factors have created a future scenario of inadequate funding in the current system without some type of major revision.

1. One proposal for fixing Social Security is to raise taxes. This could be accomplished by increasing the percentage of taxes withheld, or by eliminating the current cap on wages to which the payroll tax is withheld. Such proposals however are limited in their ability to fix Social Security in the long term.

2. Another proposal is to reduce benefit payouts. This could be done by increasing the age of full eligibility to 70 or by imposing a means test for benefits.

3. Another proposal is to reform immigration policies so that more immigrants admitted have highly valued skills for the workplace.

4. One major revision is privatizing social security. This proposal faces opposition because many realize that there is a risk that comes from enabling people to invest their own “safety net.” If an investment failed, then what would be the government’s responsibility to provide for senior citizens who might be homeless and without adequate income for food or medical necessities.

5. One proposal to increase the rate of return on Social Security contributions is a partial privatization plan, whereby workers could opt to take 2 percent of their Social Security payroll tax and invest to build their own retirement. This would mean that people could have some control over their retirement nest egg, but could not completely jeopardize their retirement income. There are numerous critics of this plan, but it is clear that some sort of overhaul to Social Security is essential if the system is to survive the retirements of the baby boomers.

G. Fiscal policy is concerned with accomplishing a specific economic goal through government spending or taxation. Fiscal policy is often based on a particular economic theory. During the Great Depression President Roosevelt relied on Keynesian economic theory that advocated increased government spending during economic recession or depression in order to stimulate the economy.

H. Monetary policy is concerned with the amount of money in circulation at a given point in time. If there is an increase in the monetary supply there will be an increased chance for inflation and an increased chance for lower interest rates. Conversely if there is a decrease in the monetary supply there will be an increased chance for low inflation and increased interest rates. However, a small change in the amount of money in circulation may not be felt by the public for eighteen months after the policy is altered.

I. In an attempt to have more ability to regulate the effect of monetary policy on the private sector, Congress established the Federal Reserve in 1913. While the president appoints members to serve on the Federal Reserve Board, he cannot replace a member until the term of office expires. This action was intended to remove the Fed from political pressure to stimulate the economy during election years for the advantage of the president’s party. The importance of the Federal Reserve could be

seen in 1998 when the Federal Reserve lowered interest rates, and the response was significant increases in stock indicators.

VII. Budget Deficits and the Public DebtA. Until 1998, the national government had spent more money than it received for nearly

every one of the past 30 years. In 2002, however, the government again began spending more money than it received. In all years but two from 1960-2002, the national government ran at a deficit. If the deficit from every year is added, it is possible to calculate the total amount of money the government owes to lenders. This amount is referred to as the national debt.

B. The process by which the federal government finances its deficits is called public debt financing. Typically this occurs when the government sells U.S. Treasury bonds. The government sells bond to private individuals and companies who invest in the U.S. government. One of the problems associated with public debt financing is that it crowds out private borrowing (people don’t invest in private enterprises because they use their income to invest in U.S. Treasury bonds). In addition, the need for the government to offer high interest rates to investors further discourages investment in private enterprise.

C. The debate surrounding budget deficits continued to rage during the 1990s, and some advocated an amendment to the Constitution requiring a balanced budget. At the time, it was thought that such an amendment would still require huge sacrifices on behalf of the public in the form of reduced services and increased taxation. But in 1998, the nearly unthinkable happened. The government operated without a deficit and even generated a surplus. While many think that the balanced budget occurred because of cuts in social spending, all analyses demonstrates that social spending increased, despite the reputation of the Republican Congress as having reduced expenditures significantly. In 1998, the budget was balanced through an increase in revenue generated by taxes. With the recession of 2001 compounded by the terrorist attacks on the United States, the tax revenue began to plummet, and expenditures increased as the government spent money to combat terrorism (and aid additional programs in the name of “security.”) These revenue reductions and increases in expenditures indicate that the problem of deficit spending and increasing public debt is with us once again.

VIII. America and the Global EconomyA. How powerful a country is depends on several factors. One of the most important

factors is the economic strength of the country. After WW II the United States was the most economically powerful country. Beginning in the 1960s the U.S. faced increased competition from Japan and West Germany in the sale of products on the world market. Yet during the late 1990s, the United States again emerged as the world economic leader, as many Asian economies faced crisis and European economies stagnated.

B. How competitive the United States remains will depend in part on the scientific knowledge for new products and the education level of the American workers to adapt to the new technologies associated with these new products. If the government does not encourage research for new products and does not invest in educational programs to produce a technologically literate work force the economic position of the country will likely continue to decline. This would mean the standard of living

for most Americans would also decline. The standard of living in the next century will depend on the economic policies of today.

This chapter focuses on the economic role of the government, stressing its promotion and regulation of economic interests and its fiscal and monetary policies that affect economic growth. The main points made in the chapter are:

Through regulation, the U.S. government imposes restraints on business activity which are designed to promote economic efficiency and equity. This regulation is often the cause of political conflict, which is both ideological and group-centered.

Through regulatory and conservation policies, the U.S. government seeks to protect and preserve the environment from the effects of business firms and consumers.

Through promotion, the U.S. government helps private interests to achieve their economic goals. Business in particular benefits from the government’s promotional efforts, which take place largely in the context of group politics.

Through its taxing and spending decisions (fiscal policy), the U.S. government seeks to maintain a level of economic supply and demand that will keep the economy prosperous. The condition of the economy is generally the leading issue in American electoral politics and has a major influence on each party’s success.

Through its money-supply decisions (monetary policy), the U.S. government—through the "Fed"— seeks to maintain a level of inflation consistent with sustained controllable economic growth.

Although private enterprise is the main force in the American economic system, the federal government plays a significant role through the policies it selects to regulate, promote, and stimulate the economy.

Regulatory policy is designed to achieve efficiency and equity, which require government to intervene, for example, to maintain competitive trade practices (an efficiency goal) and to protect vulnerable parties in economic transactions (an equity goal). Many of the regulatory decisions of the federal government, particularly those of older agencies, are made largely in the context of group politics; business lobbies have an especially strong influence on the regulatory policies that affect them. In general, newer regulatory agencies have policy responsibilities that are broader in scope and apply to a larger number of firms than those of the older agencies. As a result, the policy decisions of newer agencies are more often made in the context of party politics; Republican

administrations are less vigorous in their regulation of business than are Democratic administrations.

The U.S. government has long been active in conservation, establishing the first national park in 1872. Concern about pollution rose in the 1960s, and the government responded by creating agencies such as the EPA and enacting numerous programs and regulations to respond to those concerns. Although debate continues about the scope of those efforts, the environment has definitely benefited—the nation’s air and water are significantly cleaner than they were in the 1960s. Environmental groups are among the nation’s most powerful interest groups.

Business is the major beneficiary of the federal government’s efforts to promote economic interests. Any number of programs, including those to provide loans and research grants, are designed to assist businesses, which are also protected from failure through such measures as tariffs and favorable tax laws. Labor, for its part, gets government assistance through laws concerning such matters as worker safety, the minimum wage, and collective bargaining; yet America’s individualistic culture tends to put labor at a disadvantage, keeping it less powerful than business in dealing with the government. Agriculture is another economic sector that depends substantially on the government’s help, particularly in the form of income stabilization programs.

Through its fiscal and monetary policies, the federal government attempts to maintain a strong and stable economy—one that is characterized by high productivity, high employment, and low inflation. (See OLC graphic, "Economic Policy," at www.mhhe.com/patterson5.) Fiscal policy is based on government decisions in regard to spending and taxing, which are aimed at either stimulating a weak economy or dampening an overheated (inflationary) economy. Fiscal policy is worked out through Congress and the president and is consequently responsive to political pressures. However, because of the difficulty of either raising taxes or cutting programs, there are limits to the government’s ability to apply fiscal policy as an economic remedy. Monetary policy is based on the money supply and works through the Federal Reserve System, which is headed by a board whose members hold office for fixed terms. The Fed is a relatively independent body, a fact that has given rise to questions as to whether it should have such a large role in national economic policy.

Ch. 16 Economic Policy

Enduring Questions1. Can the president make the country prosperous?

2. Why does the government ever have a budget deficit?

3. Why does it take so long for Congress to pass a budget?

By 1999 the national debt was over 5 million dollars, it was also the first time since the 1960s that there was no deficit; that year it stopped spending more money than it collected in taxes.

Americans have long complained and told to stop the deficit. Politicians agreed with voters but did little about it. Why? There are two camps 1. Those who thought the deficit could be eliminated by cutting spending 2. Those who thought it could be eliminated by raising taxes. In general, conservatives want to cut spending and liberals want to raise taxes.

In 1996, the arguments between these groups were so intense that the Republican Congress refused to pass Pres. Clinton’s spending plan and the president refused to sign Congress’s spending bills. As a result, the government briefly ran out of money and many agencies had to close their doors.

Although politicians often attempt to take credit for eliminating the deficit, the growing and strong economy had flooded Washington with tax money.

Another problem arose: What should we do with the extra money? Republicans wanted to give the surplus back to the people, Democrats wanted to use the surplus for new programs.

George W. Bush wanted a tax cut that would total $1.6 trillion over ten years arguing the national debt would be paid down and increase Medicare and education appropriations at the same time.

Politicians hope to protect maintain Social Security --experts predict SS will start running out of money in 2033.

The Office of Management and Budget and the Congressional Budget Office try very hard to guess what our economic future will be, but they aren’t always accurate. (see figure 16.1 Bad Economic Guesses)

Two kinds of economic issues face elected officials. First, the prosperity of the nation. Second, how much money the government collects taxes and pays outh in benefits.

The Politics of Economic Prosperity

Money/Economy is always an issue just before an election. Low income people are more likely to worry about unemployment and to vote Democratic, and higher income people are more likely to worry about inflation (rise in prices/weakening purchasing power) and to vote Republican. In 1992, people who felt the economic crisis were more likely to vote for Clinton than Bush.

There is such uncertainty and complexity concerning the economy. It’s difficult to determine what the federal government can or will do to reduce unemployment, cut inflation, lower interest rates, and increase incomes just to win an election.

The Politics of Taxing and SpendingPeople want prosperity, no tax increases, no government deficit, and continued government spending on education, medical care, and the environment, and retirement benefits. Voters can’t possibly have it all because it is impossible to produce generous spending on programs with low taxes and no deficit. Majoritarian Politics: Everybody wants prosperity, and large majorities want more government spending on popular programs.

By 1999, projected budget surpluses had produced three political responses: Tax cuts, new programs or expand old programs, or reduce the debt.

How can taxes be raised without alienating voters?You raise taxes on other people. The other people are always a minority of the voters. For example, if you want to put more money into medical research, you raise taxes on cigarettes. If you want to pay for new education programs, you increase taxes on inheritances. In both cases, a minority of voters are affected. Some politicians target ordinary citizens and specific activities such as education and childcare to justify opposition to tax cut. Others hoping to lower rates look to the affluent people. Their opponents say they are trying to “soak the rich” by denying tax cuts to the people who now pay the biggest share of taxes.

Economic TheoriesPresidents rely on economic advisers who generally accept one of the following: I. Monetarism--the belief that inflation occurs when there is too much money chasing too few goods. When the federal government creates too much money, inflation occurs. When inflation becomes rampant the government trys to cut back on the amount of money in circulation. Then a recession will occur--slowed economic growth and an increase in unemployment. Monetarism suggests that government is responsible for economic problems with its start and stop habit of issuing new money. Therefore supporters of this policy recommend a steady, predictable increase in the money supply at a rate about equal to the growth in the economy’s productivity; then leave matters alone. (Milton Friedman)

II. Keynesianism

The health of the market depends on what fraction of people’s incomes they save or spend. If people save too much, demand and then production decreases, unemployment will rise as a result. If they spend too much, demand will rise too fast, prices will go up, and shortages will develop. The key is to create the right level of demand. This is the task of the government. When demand is too little, government should pump more money into the economy by spending more than it takes it in taxes. When demand is too great, the governmetn should take money out of the economy by increasing taxes or cutting expenditures. The performance of the economy is paramount/most important but Keynesians tend to favor an activist government. (John Maynard Keynes)

III. Planning The government should plan some part of the country’s economic activity. Economic planning is price and wage controls. Big corporations can raise prices because the forces of competition are too weak to restrain them, and labor unions can force up wages because management finds it easy to pass the increases along to consumers in the form of higher prices. Thus during inflationary times the government should regulate the maximum prices that can be charged and wages that can be paid, at least in the larger industries. (John Kenneth Galbraith)Industrial Policy The government should somehow direct or plan investments so that either these industries would recover or new and better industries would take their place. (Robert Reich)

IV. Supply-Side Tax CutsSupporters believe that the market has not been given an adequate chance. Supply-Side theory--less government interference in needed. For example, sharply cutting taxes will increase the incentive to work, save and invest. Greater investments would led to more jobs. More workers leads to more taxable income that adds to an increase in national income. (Arthur Laffer and Paul Craig Roberts)

Socialist Liberal Conservative

Economic planning Keynesian MonetarismSupply-side

“Reaganomics”Involved a combination of monetarism, supply-side tax cuts, and domestic budget cutting. Reagan hoped to reduce the size of the federal government, stimulate economic growth, and increase American military strength. His ideas/goals seemed rather inconsistent. Spending on domestic programs was reduced and military spending increased, and there were tax cuts but increases in Social Security taxes. There was a drop in unemployment and a rise in business activity. Reagan administration lowered taxes and increased spending, and the national debt increased.

Fiscal policy--An attempt to use taxes and expenditures to affect the economybudget deficit--government spends more than it takes in, thus pumping more money into the economy.budget surplus--government takes in more than it spends, thus draining money out of the economymonetary policy--an attempt to use the amount of money and bank deposits and the price of money (the interest rate) to affect the economy.fiscal year-- October 1 to September 30--the period of time for which federal government appropriations are made and federal books are kept.

*At one time, every U.S. dollar was backed by gold--exchanged for gold. Today the dollar is backed chiefly by public confidence rather than by a precious metal.

Economic Policy MakingTrioka--machinery making decisions about economic matters is complex and involves three people other than the president. Chairman of Council of Economic Advisers (CEA), the director of the Office of Management and Budget (OMB) and the Secretary of the TreasuryTrioka--forecasts economic trends, analyzing economic issues, and help to prepare economic reports; prepares estimates expected to be sent by federal agencies, negotiate with other departments over the size of the budgets, ensure that legislative proposals are consistent with the president’s program; provides estimates of revenue based on existing taxes, represents the US in its dealings with top bankers and finance ministers of other nations. (RESPECTIVELY)

The Fed The Board of Governors of the Federal Reserve System--seven members appointed by the president, with the consent of the Senate, for 14 year, nonrenewable terms and may not be removed except for cause. Its most important function is to regulate the supply of money (in circulation and in bank deposits) and the price of money (in the form of interest rates). Chairmen serve 4 year terms, Alan Greenspan was initially appointed by Reagan in 1987, Clinton reappointed him largely because of his success in curbing inflation. see box 467

CongressThe most important part of the economic policy making machinery is Congress. It must approve all taxes and almost all expenditures

**No matter what economic theory the president may have to look to many agencies, the Fed, and Congress

The BudgetIs a document that announces how much the government will collect in taxes and spend in revenues and how those expenditures will be allocated among various programs.

Congressional Budget Act of 1974 the president submits his budget in February. Two budget committees--the House and Senate. Each committee then submits to it house a budget resolution that proposes a total budget ceiling and a ceiling for each of several spending areas (such as defense or health).

Entitlements include Social Security and Medicare payments, veterans’ benefits, food stamps, and money the government owes investors who have bought Treasury bonds (that is, the interest on the national debt).

Sequester a provision in the bill (Gramm Rudman Act- designed to Balanced Budget of 1985) that required across the board percentage cuts in all federal programs in the president and Congress failed to agree on a total spending level that met the law’s target.

p. 474 Federal Taxes on income graphp.475 Federal Income Tax Policy box

The Savings and Loan MessCreated to help the average person purchase a home. S&L offered depositors relatively low interest rates and when other financial institutions (certificates of deposits and money market funds) offered higher rates people took money out of S&L were allowed to pay. S&Ls were losing money and so they went to Congress for help. They received the assistance and were allowed to pay higher interest in order to attract deposits.

The immediate problem was the S&L received 6 percent from the low-interest days of the 1950s and 1960s. When the 9 percent or 10 percent interest, it started to lose money. The S&L returned to Congress and asked for permission to invest in things that would earn them a higher return than a home mortage. Congress granted permission and S&Ls begin investing in shopping malls, farmland, and high yield junk bonds. S&Ls began investing in high risk deals deals that would pay off handsomely if they worked out but would cause big losses if they didn’t. Many didn’t. Savings and Loans were not worried because the government had promised to pay off these depositors if anything went wrong. In effect, the S&Ls were playing with free money.

In the early 1980s, many S&Ls went bankrupt--they couldn’t earn enough money from their loans to pay what they owed their depositors. So the federal government had to bail them out paying off depositors.

Many S&Ls made big contributions to politicians to get them to persuade federal regulators not to declare S&Ls bankrupt/busted/ruined.

In 1989 Congress passed a law to bail out the system by paying $50 billion to close insolvent institutions and pay off the depositors. The law also reorganized and tightened federal regulation of the thrifts. Problems persisted and may cost each taxpayer up to $2000.

Economic Theories

Presidents rely on economic advisers who generally accept one of the following:

I. Monetarism--the belief that inflation occurs when there is too much money chasing too few goods. When the federal government creates too much money, inflation occurs. When inflation becomes rampant the government tries to cut back on the amount of money in circulation. Then a recession will occur--slowed economic growth and an increase in unemployment. Monetarism suggests that government is responsible for economic problems with its start and stop habit of issuing new money. Therefore supporters of this policy recommend a steady, predictable increase in the money supply at a rate about equal to the growth in the economy’s productivity; then leave matters alone. (Milton Friedman)

II. KeynesianismThe health of the market depends on what fraction of people’s incomes they save or spend. If people save too much, demand and then production decreases, unemployment will rise as a result. If they spend too much, demand will rise too fast, prices will go up, and shortages will develop. The key is to create the right level of demand. This is the task of the government. When demand is too little, government should pump more money into the economy by spending more than it takes it in taxes. When demand is too great, the government should take money out of the economy by increasing taxes or cutting expenditures. The performance of the economy is paramount/most important but Keynesians tend to favor an activist government. (John Maynard Keynes)

III. Planning The government should plan some part of the country’s economic activity. Economic planning is price and wage controls. Big corporations can raise prices because the forces of competition are too weak to restrain them, and labor unions can force up wages because management finds it easy to pass the increases along to consumers in the form of higher prices. Thus during inflationary times the government should regulate the maximum prices that can be charged and wages that can be paid, at least in the larger industries. (John Kenneth Galbraith)

IV. Industrial Policy The government should somehow direct or plan investments so that either these industries would recover or new and better industries would take their place. (Robert Reich)

V. Supply-Side Tax CutsSupporters believe that the market has not been given an adequate chance. Supply-Side theory--less government interference in needed. For example, sharply cutting taxes will increase the incentive to work, save and invest. Greater investments would led to more jobs. More workers lead to more taxable income that adds to an increase in national income. (Arthur Laffer and Paul Craig Roberts)

Socialist Liberal Conservative

Economic planning Keynesian MonetarismSupply-side

GUIDED READING: ECONOMIC AND REGULATORY POLICY

1. Recessions take place when the economy actually shrinks for at least _____months.

2. ______________ refers to a sustained rise in the general price level of goods and services.

3. Full employment

4. During the Great Depression, unemployment peaked at over ________ percent.

5. The Great Depression ended majority support for ___________________economics.

6. Among the unemployed, ________ are eligible for unemployment benefits.

7. Today's dollar is worth about how much relative to a dollar of a century ago?

8. The _______ is a measure of the change in price over time of a specific group of goods and services used by the average household.

9. By the mid-2000s, ______________was increasing at a rate of 3 to 4 percent a year.

10. The business cycle may be misnamed, because modern "__________" and "_________" vary greatly in length.

11. John Maynard Keynes is associated with _____________ policy.

12. Fiscal policy:

13. Fiscal policy theory says that when the economy enters a recession, the government should ________________.

14. Fiscal policy theory says that when the economy is faced with inflation, the government should_______________________________________.

15. The first president to openly adopt Keynesian economics was ____________.

16. The policies advocated by which two presidents resulted in significant fiscal policy failures?

17. President Nixon sought to fight inflation by ___________________________.

18. The ___________ _________ debt is defined as the total amount owed by the federal government to individuals, businesses and foreigners.

19. Gross public debt:

20. The gross domestic product (GDP)

21. Compared to the size of the _____, the net public debt peaked during World War II.

22. The only president of recent times to actually run a budget surplus, as opposed to a deficit, was _______________________.

23. The predictions of experts in the late twentieth century that we would be running budget surpluses for years to come proved to be as inaccurate as they were optimistic. Deficit spending became a reality once again by the middle of the first decade of the twenty-first century. How can this be explained?

24. Monetary policy:

25. What is the responsibility of the Federal Open Market Committee?

26. ____________ policy that makes credit expensive in an effort to slow the economy may be used in an effort to control inflation.

27. Monetary policy theory says that when the economy enters a recession, the government should _______________ the rate of growth of the money supply.

28. Monetary policy theory says that when the economy is faced with inflation, the government should ________________ the rate of growth of the money supply.

29. The Fed's greatest blunder occurred during the _______________________.

30. _____________ policy may have limited power to end a recession because people may be unwilling to borrow even if interest rates fall to zero.

31. In a Gallup poll conducted in 2006, it was revealed that ___ of Americans believed that trade between the United States and other countries hurt U.S. workers.

32. While the American public is skeptical of the benefits of _______________ trade, most economists believe that it benefits the U.S. economy greatly.

33. Today, imports make up about _____ percent of the goods and services that we buy in the United States.

34. The United States exports about ___ percent of the gross domestic product.

35. Since 1950, world trade has increased by more than twenty times.

36. In the long run, imports are paid for by ______________.

37. __________ are taxes on imports.38. ____________ created a free-trade zone between the United States and Canada and Mexico.

39. Describe the World Trade Organization:

40. Because the United States imports more goods and services than it exports, the _____________________________ and the current account balance are negative.

41. Because the United States imports more than it exports, foreigners make up the difference by investing funds in America.

42. In the last twenty years the United States has enjoyed a larger share of the world's economic growth than any country other than _________________.

43. The total of all taxes collected by the various levels of government in the United States is about___________ percent of the gross domestic product.

44. Tax loopholes allow individuals and corporations to reduce their taxable income legally.

45. With a progressive tax people with higher incomes pay taxes at a higher percentage rate.

46. What taxes are considered to be generally progressive in their effect?

47. ________________________ is a pay-as-you-go system where those currently working support those who are retired.

48. Today, _____workers provide for each retiree's benefits, as compared with 42 in 1946.

49. What are the possible solutions advanced by our political leaders to help ensure Social Security's solvency in the future?

50. If the government sought to balance the budget by raising taxes on individuals, the tax rates paid by _________ would have to rise dramatically.

51. "_______________" restrictions on Japanese car imports by one calculation, cost consumers about $250,000 per year for each job saved.

52. Although hundreds of thousands of jobs are ____________________ to other nations, this loss represents a small percentage when it is considered that the U.S. labor market is close to 140 million people.

53. ___________________ of Social Security means allowing workers to invest part or all of their Social Security taxes in the stock market.

ESSAY

54. Explain the circumstances that would arise if the federal government was required to balance its budget.

ANS: Students' answers may vary.REF: What If The Federal Government Was Required to Balance Its Budget?

55. How has the government attempted to address the problem of unemployment?

ANS: Students' answers may vary.

56. Explain the impact of Keynesian Economics on fiscal policy in the United States. What were the most impressive instances of Keynesian Economics at work in our government? What were the most disastrous?

ANS: Students' answers may vary.

57. Explain how the United States went from having a budget surplus at the end of the Clinton Administration to shouldering a $300 billion deficit for 2006.

ANS: Students' answer may vary.

58. Explain the difference between loose and tight monetary policy and when they would be appropriate policy options.

ANS: Students' answers may vary.

59. Contrast the views of economists and the American people on the issue of world trade.

ANS: Students' answers may vary.

60. Explain the costs associated with governmental action to protect American jobs and whether those costs outweigh the benefits.

ANS: Students' answers may vary.REF: Politics and Trade—The High Cost of Saving U.S. Jobs

61. Explain the role of the World Trade Organization and whether the United States should attempt to play a major role in its operation.

ANS: Students' answers may vary.

62. Is outsourcing of American jobs really the problem that so many politicians make it out to be?

ANS: Students' answers may vary.REF: Sending Work Overseas

63. Explain the difference between progressive and regressive taxes. Would we be better served by simply employing a flat tax across the board?

ANS: Students' answers may vary.

64. Explain the theory behind the creation of Social Security, the problems that arise from its operation and possible solutions to save it.

ANS: Students' answers may vary.

Defense Spending

The ARRA will add an extra $7.03 billion to the defense budget with about $4.2 billion set aside to modernize and repair facilities. There will be $1.3 billion for military family medical care. Billions more will be spent on everything from housing to National Guard facilities.

Education

The majority of the education spending, around $15.6 billion, will go towards the Pell Grant Program. There is $13 billion set aside for low-income school children and $12.2 billion for special education. There is also money for childcare and Head Start.

Health Care

The ARRA act sets aside $19 billion for health care information technology and another $2 billion for Community Health Centers. There is $500 billion appropriated for training health care professionals like nurses.

Social Spending

Appropriations include $4 billion to modernize public housing, $19.9 billion for Food Stamps and $3.95 billion for job training. Social Service spending will be at least $38 billion. See Housing, Hunger and Job Assistance below.

Research

There is at least $17 billion in the bill for research spending. There is money available for research into health ailments, NASA and Energy. There is $1.3 billion set aside to upgrade the university research centers around the country.

Transportation Projects

There is at least $48 billion in transportation projects in the bill. $27.5 will go towards highway and bridge construction. Local governments will get $1.5 billion for roads. There is $1.3 billion for Amtrak and another $750 million for new rail construction. See the complete list below.

By Dan Wilson

American Recovery and Reinvestment Act of 2009  

Defense Spending  Repair and modernize Department of Defense facilities $4.2 billionMedical care for service members and their families $1.3 billionImprove housing for service members $890 millionNew child development centers $240 millionConstruction of state extended-care facilities $150 millionIncrease of claims processing staff $150 millionImprove facilities of the National Guard $100 million   Schools  Increase Pell Grants by $500 to $5,350 $15.6 billionLow-income public schoolchildren $13 billionIDEA special education $12.2 billionHead Start $2.1 billionChildcare services $2 billionEducational technology $650 millionIncreased teacher salaries $300 millionStates to analyze student performance $250 millionSupport working college students $200 millionEducation of homeless children $70 million   Energy  Funding for an electric smart grid $11 billionState and local governments to make investments in energy efficiency $6.3 billionRenewable energy power generation loans $6 billionWeatherizing modest-income homes $5 billionState and local governments to increase energy efficiency in federalbuildings $4.5 billion

Carbon capture experiments $3.4 billionEnergy efficiency research $2.5 billionCar battery research $2 billionTraining of green-collar workers $500 millionElectric vehicle technologies $400 millionBuy energy efficient appliances $300 millionReducing diesel fuel emissions $300 millionState and local governments to purchase energy efficient vehicles $300 millionIncrease energy efficiency in low-income housing $250 million   Environmental cleanup  Cleanup of radioactive waste $6 billionCleanup hazardous waste that threaten health and the environment $600 millionCleanup petroleum leaks from underground storage tanks $200 millionEvaluate and cleanup brownfield land $100 million   Government technology improvements  Computer center at the Social Security Administration $500 millionUpgrade IT platforms at the State Department $290 millionIT improvements at the Farm Service Agency $50 millionImprove security systems at the Department of Agricultureheadquarters $24 million

   Healthcare  health information technology $19 billionCommunity Health Centers $2 billionEffectiveness of certain healthcare treatments $1.1 billionFight preventable chronic diseases $1 billionTrain healthcare personnel $500 millionHealthcare services on indian reservations $500 million   Housing  Repairing and modernizing public housing $4 billionTax credits for financing low-income housing construction $2.25 billionSection 8 housing rental assistance $2 billionCommunities purchase and repair foreclosed housing $2 billionRental assistance and housing relocation $1.5 billionRehabilitation of Native American housing $510 millionHelping rural Americans buy homes $200 millionRural community facilities $130 million

Help remove lead paint from public housing $100 million   Hunger assistance  Food Stamp Program $19.9 billionHelp refill food banks $150 millionMeals programs for seniors, such as Meals on Wheels $100 millionFree school lunch programs $100 million   Job assistance  Job training $3.95 billionVocational training for the disabled $500 millionEmployment services $400 millionSubsidized community service jobs for older Americans $120 million   Scientific research  National Institutes of Health $8.7 billionNational Science Foundation $3 billionUnited States Department of Energy $2 billionUniversity research facilities $1.3 billionNASA $1 billionNational Oceanic and Atmospheric Administration (NOAA) $600 millionNational Institute of Standards and Technology $580 millionNOAA operations, research and facilities $230 millionUnited States Geological Survey $140 million   Transportation projects  Highway and bridge construction projects $27.5 billionHigh-speed rail projects $8 billionNew equipment for public transportation projects $6.9 billionCompetitive grants to state and local governments for transportationinvestments $1.5 billion

 Amtrak $1.3 billionImproving airport security $1.1 billionConstruction of new public rail transportation systems $750 millionMaintenance of existing public transportation systems $750 millionImproving security at the border and ports of entry $720 millionMaintenance of United States Coast Guard facilities $240 million   Veterans Affairs facilities  Veterans Health Administration $1 billion

National Cemetery Administration $50 million   Telecommunications  Complete broadband and wireless Internet access $7.2 billionDTV conversion coupons $650 million

Aggregate demand

Also more accurately referred to as aggregate expenditure, this is one of the key concepts introduced by John Maynard Keynes that still today is at the heart of most macroeconomic theories about the determination of the overall level of employment (and thus the level of national income produced) in a country's economy during a given year. Although there have turned out to be a number of logical problems and ambiguities in making the analogy work, Keynes's original basic notion was that “aggregate demand” represented a sort of grand total or summarization of all the various demand schedules for all the millions of different goods and services produced in a country's national economy. Thus, Keynes reasoned, just as the micro economic theorist can fruitfully analyze the relationship between the various quantities of a particular good or service that will be purchased by consumers at various prices on a single market by means of a demand schedule or demand curve, the macro economic theorist can make similarly good use of an aggregate demand schedule or aggregate demand curve as a means for analyzing the relationship between the various possible grand totals of all goods and services purchased in the national economy (as measured by their total monetary value in the form of a national product estimate like GNP or GDP) and the general price level (as measured by some sort of comprehensive price index rather like those whose yearly rates of change are commonly used to measure inflation). Once he had the brainstorm that one could sum up all the demand schedules for individual goods into a single grand total “aggregate demand schedule,” it was not much of a mental leap for Keynes to conclude that it might be useful first to divide up aggregate demand into a small number of “subtotal” aggregate demand schedules whose interrelationships might help explain such large-scale macroeconomic phenomena as the business cycle, inflation, economic growth and the like. Thus Keynes invented most of the basic

ideas of what is today the macroeconomists' conventional system of national income accounting when he formulated his famous aggregate demand identity

Y = C + I + G + (X - M)

which simply means that a single country's aggregate demand for national product (Y) is always equal to the total demands of its households for Consumer goods and services (C), plus the total demands of its firms for Investment goods (I), plus the total demands of its various Government agencies for goods and services (G), plus the net demands of foreign consumers, firms and governments for the country's goods and services (exports minus imports).

Aggregate supply

Another of the concepts introduced by John Maynard Keynes that still today are used in macroeconomic theories about the determination of the overall level of employment and national income. Like his concept of aggregate demand, the basic notion of aggregate supply was created by analogy to a microeconomic concept originally applying only to an analysis of the market for a single product — in this case, the concept of a supply schedule. Thus, Keynes reasoned, just as the micro economic theorist can fruitfully analyze the relationship between the various quantities of a particular good or service that will be produced and offered for sale by firms at various prices on a single market by means of a supply schedule or supply curve, the macro economic theorist can make similarly good use of an aggregate supply schedule or aggregate supply curve to depict the relationship between the various possible grand totals of all goods and services produced and offered for sale in the national economy (as measured by their total monetary value in the form of a national product estimate like GNP or GDP) and the general price level (as measured by some sort of comprehensive price index rather like those whose yearly rates of change are commonly used to measure inflation).

Allocation

The division of things into shares or portions. In economics, the term refers primarily to the “allocation of resources,” the process by which economic resources get allotted (apportioned, assigned) to their particular uses for directly

or indirectly satisfying human wants. The allocation process in a particular society's economy is the process by which the three fundamental economic questions get answered in that society:

1. What goods and services are produced (and in what quantities)? 2. By which of the various available technological means and recipes are

each of these goods and services to be produced from the available land, labor and capital?

3. For whom are each of these goods and services produced? (Which specific individuals get to use/consume each unit of each good or service produced?)

Thus one may speak of “market allocation” of resources, “forcible allocation” of resources, “governmental allocation” of resources, “traditional” (or “customary”) allocation of resources and so on, depending upon the kinds of social processes and incentives by which various sorts of scarce resources are allocated in the particular society under consideration.

Appropriation bill

A (proposed) formal action by a legislative assembly (such as the U.S. Congress or a state legislature) that specifies exact amounts of the government's money that the Treasury may legally pay out (through new hiring, contracts for purchases, findings of individuals' eligibility for income transfer payments, etc.) for each of a list of particular pre-authorized programs carried out by governmental agencies over a specific period of time (normally one year).

Authorization bill

A (proposed) formal act (or “law”) of a legislative body (such as the U.S. Congress or a state legislature) that legally establishes a new government agency or program or else renews or extends an existing agency or program whose previous legal authorization to exist would otherwise expire with the passage of time. Authorizations may be for one year or more than one year — about one-half of current Federal spending is by agencies or programs subject to annual re-authorization, while the other half gets its legal basis either from longer term authorization bills or from permanent laws that provide spending authority automatically to ongoing entitlement programs like Social Security. Authorization bills also include specific figures as funding levels for the agencies and programs,

but these sums are upper limits only (for the guidance of the appropriations committee) — no money can actually be spent or committed by the agency or program administrators until after a separate appropriation bill has also been passed and signed into law, legally enabling the Treasury to disburse the money. The amount of money eventually appropriated for an agency or program is most often less than the amount previously authorized, so an authorization bill is rather like a necessary “hunting license” for an appropriation rather than a guarantee. No appropriation can be made for an unauthorized program, but even an authorized program may still die or be unable to perform all its assigned functions for lack of a sufficiently large appropriation of funds. This often happens in the decentralized American political system, because authorization bills are each drafted by one of the many specialized standing committees in Congress (the Agriculture Committee, the Armed Forces Committee, etc. — who tend to be cheerleaders for “their” pet agencies), while appropriation bills are drafted by the different set of lawmakers who serve on the specialized subcommittees of the Appropriations committees in the two chambers (who still have to get their funding choices through the full Appropriations committee, which is responsible for weighing the relative merits and urgency of all the different programs against each other before dividing up the budget pie).

Banking

In the broadest sense of the term, “banking” is the business of accepting temporary responsibility for safeguarding other people's money (“deposits”) and then lending out these funds (along with the bankers' own funds) in order to earn interest for the bank's own account. Banking firms thus earn their profits primarily by serving as “financial intermediaries” who mobilize the scattered savings of many households and firms (by offering safekeeping services and paying interest on at least some kinds of accounts) and then make these pooled funds available to suitable borrowers (to business firms that want to finance proposed investment projects or perhaps to consumers who want to finance big ticket durable consumers' goods like automobiles or perhaps to governmental entities whose policy-makers have decided to spend more money than they have received in revenue collections). The bank pledges its own capital (and also buys outside deposit insurance) to guarantee that any depositor can get all his/her money back in cash no later than some contractually specified length of time after giving

notice of withdrawal. The bank makes this somewhat risky guarantee even though it is quite predictable that some (hopefully small) percentage of the loans the bankers make using depositers' funds will “turn sour” and not be repaid by the borrower. The bank's profits arise mainly from the (positive) spread between its costs of securing and servicing deposits and its revenues from fees and interest on the loans extended. (Of course banks frequently seek to make additional profits selling other financial services to their clients and customers as well, but the business of accepting deposits and making loans is the defining core of the banking business.)

Not all firms engaging in “banking” in this broad sense are officially called “banks.” Savings and loan associations, credit unions and other miscellaneous thrift institutions provide similar services under other names. The laws of the United States and most other developed industrial countries provide for multiple types of financial intermediary institutions whose official “labels” normally depend upon the selected purposes for which they will loan money (business loans, consumer loans, real estate mortgages, etc.), the maximum time period for which they will contract a loan (2 years? 5 years? 30 years?), and the kinds of supplementary services (checking privileges, foreign exchange, management of trusts and estates, etc.) that they may provide for their customers beyond basic taking of deposits and extension of loans.

From the perspective of this course, banks are mainly of interest because of their key role in determining the size of the money stock. Considerably less than half of the US money stock (M1) consists of physical cash or currency (coins and bills). Most of the money stock in the US (or any other present-day advanced industrial economy) is in the form of “mere” ledger entries representing bank depositers' credit balances in their individual or corporate checking accounts. And, amazingly enough to the uninitiated, this means that banks are constantly creating money “out of thin air” simply by making bookkeeping entries that assign new checking account credits to customers as they take out loans from the bank.

Of course, private banks cannot simply create money out of thin air without limit and still expect to stay in business. When the bank credits a borrower's account with the amount of his new loan, it is to be expected that the borrower will very soon want to spend part or all of the money he has borrowed. After the check the borrower writes is deposited in somebody else's account in another bank, the

check will soon be presented for collection at the lending bank, and they will have to have the cash on hand to pay the other bank off at that time. The more dollars' worth of loans a bank has extended, the more cash it will have to have on hand in reserves to meet the daily flow of redemptions. Most or all of the check redemption demands coming in every day can normally be offset by the cash and checks drawn on other banks that the depositers and borrowers have brought in and deposited or paid that day, but an “unsound” bank that extends loans with reckless abandon sooner or later will find that the flow of checks presented to it for collection greatly exceeds the flow of outside checks and cash being brought in. Once the bank's vaults are empty and the cash reserves are gone, the management must quickly (overnight!) either borrow the necessary additional cash elsewhere (probably at high interest rates) or else sell off some of the bank's assets (because of the haste, probably at fire-sale prices). When the troubled bank can no longer borrow and has no assets left that can be sold on short notice, it can no longer fulfill its ontractual guarantees to pay its obligations on demand and is therefore out of business with the banks owners and managers now subject to civil (and perhaps criminal) legal penalties (bankrupcy, suits for breach of contract, negligence, and fraud, indictments for fraud, embezzlement, etc.).

“Sound” banks limit the volume of the loans they extend so that they remain in a prudent proportional relationship to the amount of instantly liquid funds they have available in “reserves” (either as currency in the vault or as demand deposits in some other bank, such as the Federal Reserve). But bankers face a difficult trade-off. The flow of checks that will be presented for payment and the volume of new deposits and loan repayments coming in every day cannot be predicted with 100% accuracy, so the higher the fraction of its total deposit obligations the bank holds ready in reserves, the safer or “sounder” the bank can be considered (and the more attractive the bank will seem to depositers and other potential business associates). However, reserves do not yield any interest income to the bank; only the funds that are tied up in loans to (solvent) borrowers can contribute directly and immediately to the bank's profitability. To maximize their profits, bank management must find the best way to strike a balance between the need to maintain their “reserve ratio” at a level high enough to limit their risks of becoming insolvent and the conflicting need to keep the highest feasible proportion of the bank's available funds loaned out at interest.

Budget

A statement of a government's planned or expected financial position for a specified period of time (usually one year) based on estimates of the expenditures to be made by the government's main subdivisions (wages and salaries of government employees; consultants' fees; purchases of equipment, supplies, real estate, etc.; money transferred to beneficiaries of various programs, and so on) during the specified period, along with estimates of the revenues to be realized from the various sources of income that will be available for paying for these expenditures. The budget of a government may be seen as a comprehensive plan of what the government will spend for its various programs during the next fiscal year and how it expects to raise the money to pay for them (tax receipts, charges for services, sale of assets, borrowing, new emissions of currency, etc.) Somewhat confusingly, the same term is used to denote both the advance estimate or plan of what the government will be taking in and spending and also the actual amounts that finally end up being taken in and spent — even though the planned and actual numbers never really match perfectly when the returns come in!

Budget deficit

The amount by which total government spending is more than government income during a specified period; the amount of money which the government has to raise by borrowing or currency emission in order to make up for the shortfall in tax revenues.

Budget surplus

The amount by which government revenues are more than government spending during a specified period.

National debt

As usually defined, this denotes the total sum of the outstanding debt obligations of a country's central government. (But occasionally writers may use the term somewhat more broadly to refer to the total indebtedness of all levels of government, including regional and local governments, and sometimes also the indebtedness of government owned business entities such as local transit and communications systems or nationalized industries as well.) The national debt

represents the accumulated total of all the government budget deficits of past years, less the accumulated total of all the government budget surpluses of past years. For most developed countries, such as the United States, the national debt consists almost entirely of interest-bearing "IOU" instruments that are usually re-sellable on organized financial markets (such as, for example, U.S. bonds, U.S. treasury notes, and U.S. treasury bills). These IOUs are originally purchased from the Treasury by private individuals, private corporations, insurance companies, pension funds and banks (both inside the United States and outside its borders), and the Treasury then uses the money thus raised to bridge its spending gap when its budget is in deficit. (The Treasury also sells IOUs to other Federal agencies that operate so-called trust funds -- primarily the Social Security Administration and other Federal retirement programs -- but since this is money that the government "owes to itself," it is not counted as part of the national debt in any realistic system of accounting.) Money to pay the annual interest owed to the owners of the government's debt instruments has to be provided through appropriations in every year's Federal budget and, indeed, these interest payments on the national debt nowadays always constitute one of the two or three largest spending categories in the budget.

Monetary policy

That part of the government's economic policy which tries to control the size of the total stock of money (and other highly liquid financial assets that are close substitutes for money) available in the national economy in order to achieve policy objectives that are often partly contradictory: controlling the rate of increase in the general price level (inflation), speeding up or slowing the overall rate of economic growth (mainly by affecting the interest rates that constitute such a large share of suppliers' costs for new investment but partly by influencing consumer demand through the availability of consumer credit and mortgage money), managing the level of unemployment (stimulating or retarding total demand for goods and services by manipulating the amount of money in the hands of consumers and investors), or influencing the exchange rates at which the national currency trades for other foreign currencies (mainly by pushing domestic interest rates above or below foreign interest rates in order to attract or discourage foreign savings from entering or leaving domestic financial markets). Monetary policy is said to be "easy," "loose," or "expansionary" when the quantity of money

in circulation is being rapidly increased and short-term interest rates are thus being pushed down. Monetary policy is said to be "tight" or "contractionary" when the quantity of money available is being reduced (or else allowed to grow only at a slower rate than in the recent past) and short-term interest rates are thus being pushed to higher levels.

The government's ability to control the size of the money stock and the levels of interest rates is only partial, not absolute. This is because monetary policy makers must rely mainly on influencing the privately-owned banking system's supply schedule for loaned funds. Monetary policy makers are much less able to affect the private sector's demand schedule for such funds, yet both supply and demand for money interact to determine the quantity of money created and its price, the interest rate. Even in trying to control the supply side of the loan market, it is easier for the Fed to force the banks to tighten credit and make fewer new loans (by raising the legal reserve requirements, for example) than it is to convince them to extend a larger volume of loans when bankers have become worried about their prospects for being repaid (or fear rapid inflation will cause their repayments to be worth less than the original value of the their loans). Government monetary policy-makers are generally much more successful in manipulating short-term interest rates (rates on loans for periods of less than a year) than they are in manipulating medium-term interest rates (1 to 5 years) and long-term interest rates (more than five years). This is because demand and supply for medium-term and long-term loans tend to be both much more elastic and much more affected by the public's expectations about future rates of inflation than the supply and demand for short-term loans are. A very expansionary monetary policy may well lower short-term interest rates by flooding the banks and financial markets with loanable funds and yet at the same time may actually raise longer-term interest rates by prompting fears among lenders that inflation will soon be accelerating. Unfortunately, medium and long-term interest rates have much more influence on the rate of growth of the economy and on levels of unemployment than short-term interest rates do, because major new investment spending like research and development for new products or the construction of whole new factories are long-term projects that require long-term financing, and they are much less likely to be undertaken if long-term interest costs are high than if they are low.

Capital

The existing stock of goods which are to be used in the production of other goods or services and which have themselves been produced by previous human activities. Capital is conventionally subdivided into "fixed capital" and "circulating capital," although the distinction is mainly a matter of degree of durability rather than a clear-cut difference in kind. Fixed capital refers to durable producers' goods such as buildings, plant and machinery, while circulating capital refers to stockpiles of materials, semi-finished goods, and components that are normally used up very rapidly in production. Notice that "capital" in the strictest economic sense refers only to real, physical means of production already in being, not to the sums of money put aside through savings to purchase real capital with in the future (although the total amount of capital in a particular firm may for convenience be described or summarized in monetary terms by the potential resale values of all the separate items of capital added together in one grand sum).

Capital

The existing stock of goods which are to be used in the production of other goods or services and which have themselves been produced by previous human activities. Capital is conventionally subdivided into "fixed capital" and "circulating capital," although the distinction is mainly a matter of degree of durability rather than a clear-cut difference in kind. Fixed capital refers to durable producers' goods such as buildings, plant and machinery, while circulating capital refers to stockpiles of materials, semi-finished goods, and components that are normally used up very rapidly in production. Notice that "capital" in the strictest economic sense refers only to real, physical means of production already in being, not to the sums of money put aside through savings to purchase real capital with in the future (although the total amount of capital in a particular firm may for convenience be described or summarized in monetary terms by the potential resale values of all the separate items of capital added together in one grand sum).

Capitalism

A form of economic order characterized by private ownership of the means of production and the freedom of private owners to use, buy and sell their property or services on the market at voluntarily agreed prices and terms, with only

minimal interference with such transactions by the state or other authoritative third parties.

Commerce clause

The provision of the U.S. Constitution (Article I, Section 8, paragraph 3) that gives Congress the authority to regulate trade with foreign nations and among the states.

Communism 1. Any ideology based on the communal ownership of all property and a

classless social structure, with economic production and distribution to be directed and regulated by means of an authoritative economic plan that supposedly embodies the interests of the community as a whole. Karl Marx is today the most famous early theoretician of communism, but he did not invent the term or the basic social ideals, which he mostly borrowed and adapted from the less systematic theories of earlier French utopian socialists -- grafting these onto a philosophical framework Marx derived from the German philosophers Hegel and Feuerbach, while adding in a number of economic theories derived from his reinterpretation of the writings of such early political economists such as Adam Smith, Thomas Malthus, and David Ricardo. In most versions of the communist utopia, everyone would be expected to co-operate enthusiastically in the process of production, but the individual citizen's equal rights of access to consumer goods would be completely unaffected by his/her own individual contribution to production -- hence Karl Marx's famous slogan "From each according to his ability; to each according to his need." The Marxian and other 19th century communist utopias also were expected to dispense with such "relics of the past" as trading, money, prices, wages, profits, interest, land-rent, calculations of profit and loss, contracts, banking, insurance, lawsuits, etc. It was expected that such a radical reordering of the economic sphere of life would also more or less rapidly lead to the elimination of all other major social problems such as class conflict, political oppression, racial discrimination, the inequality of the sexes, religious bigotry, and cultural backwardness -- as well as put an end to such more "psychological" forms of suffering as alienation, anomie, and feelings of powerlessness.

2. The specifically Marxist-Leninist variant of socialism which emphasizes that a truly communist society can be achieved only through the violent overthrow of capitalism and the establishment of a "dictatorship of the proletariat" that is to prepare the way for the future idealized society of communism under the authoritarian guidance of a hierarchical and disciplined Communist Party.

3. A world-wide revolutionary political movement inspired by the October Revolution (Red Oktober) in Russia in 1917 and advocating the establishment everywhere of political, economic, and social institutions and policies modeled on those of the Soviet Union (or, in some later versions, China or Albania) as a means for eventually attaining a communist society.

Socialism

A class of ideologies favoring an economic system in which all or most productive resources are the property of the government, in which the production and distribution of goods and services are administered primarily by the government rather than by private enterprise, and in which any remaining private production and distribution (socialists differ on how much of this is tolerable) is heavily regulated by the government rather than by market processes. Both democratic and non-democratic socialists insist that the government they envision as running the economy must in principle be one that truly reflects the will of the masses of the population (or at least their "true" best interests), but of course they differ considerably in their ideas about what sorts of political institutions and practices are required to ensure this will be so. In practice, socialist economic principles may be combined with an extremely wide range of attitudes toward personal freedom, civil liberties, mass political participation, bureaucracy and political competition, ranging from Western European democratic socialism to the more authoritarian socialisms of many third world regimes to the totalitarian excesses of Soviet-style socialism or communism.

Business cycle

More or less regular swings or wave-like fluctuations in the pace of a country's economic growth, well above and well below the long-term trend in the growth rate of total production; the ups and downs of overall business activity, as

evidenced by surges and declines in GNP and GDP, unemployment rates, and the general price level; the boom-and-bust pattern of recession (or depression) and recovery. In older economic literature (and still today in British usage) the term “trade cycle” is often used as a synonym for “business cycle.”

What causes business cycles has been one of the hottest and longest running theoretical debates in political economy. There is a fair amount of agreement on what at least some of the factors are that are associated with the alternation of economic booms and busts, but different schools of thought differ considerably in the relative weight and the causal priority they assign to these various factors. Some schools of thought emphasize uneven government economic policies as the principal cause of business cycles, while others see government economic policies as the key influences working to even out business cycles allegedly brought on by inherent features of the market economy.

Nearly all of these competing theories key in on one or more of the factors believed to influence the expansion and contraction of total saving by the public and of new capital investment undertaken by business firms as the most immediate causes of booms and busts in the larger economy.

John Maynard Keynes's explanation of the business cycle emphasized periodic shifts in the public's allocation of their incomes between current spending for immediate consumption and savings for future consumption — which leads to shifts in the overall level of demand for consumers' goods, which in turn encourages producers of consumers' goods disproportionately to expand or contract their own purchases of producers's goods like raw materials and machinery (and labor) more or less all at once in response to improvements or declines in their current sales. Keynes believed that the public typically tends to save too much and consume too little, thereby throttling aggregate (total) demand, unless the government steps in from time to time through its fiscal policies to artificially increase aggregate demand by spending more on goods and services than it takes away from consumers' purchasing power in taxes (“running a budget deficit”).

Other non-Keynesian theorists of the business cycle have focussed on other (often psychological) factors besides the growth or decline of their current sales that influence businessmen's optimism or pessimism about future economic conditions

(and hence their investment plans). Still other theorists emphasize the role of occasional “supply shocks” — sudden and unexpected changes in the supply of key resources resulting from weather cycles, natural disasters, international conflicts, big regulatory or tax changes by government, etc. (For example, the formation of the OPEC oil producers' cartel and their two massive waves of concerted production cuts/price increases in the 1970s.) Joseph Schumpeter's theory of “creative destruction” stresses the role of waves of massive innovation (major technological breakthroughs, introduction of major new products that create whole new industries) in precipitating major adjustments and reallocation of resources as old industries die and are replaced by new ones. “Monetarist” theories of the business cycle analyze the impact of shifts in decisions of the government monetary authorities (such as the Board of Governors of the U.S. Federal Reserve Banking System) to expand or contract the money supply in their efforts to manipulate short-term interest rates and foreign exchange rates (often for selfish political reasons). “Supply-side” theorists of the business cycle tend to emphasize the impact of periodic changes in government tax policies (especially changes in the marginal rates of taxation on various forms of investment expenditures and business income) as the major precipitant of booms and busts.

Deflation

The opposite of inflation -- that is, a sustained fall over time in the general level of prices, normally measured by the annual percentage increases or decreases of a weighted index of prices of some large and representative sample of goods and services (both consumers' goods and producers' goods) regularly traded in the particular economy under consideration. Just as very large scale inflations are normally the result of large percentage increases in the money stock, large-scale deflations are normally the consequence of substantial reductions in the available money stock.

Competition

Competition is one of the most important concepts in economics, yet when examined closely, it turns out to be one of the most elusive concepts to nail down in practice. A market in some particular good or service is said by economists to be "competitive" if a substantial number of buyers and sellers trade in the good or service independently and thus no single buyer or seller is so "weighty" in the

marketplace as to significantly influence the going price of the good or service by his/her individual decisions about how many units he personally will buy or sell.

The practical problems (and disagreements) in assessing whether a particular market is "competitive" or not arise when you look at the real world and try to specify the geographic boundaries of the market and the breadth or narrowness of the definition of the good on which you are focussing. Billy-Bob Motors may have the only Ford dealership in town, giving him a "monopoly" in some very narrow sense -- but local car buyers will be quick to travel to other Ford dealerships in any of a number of other cities or towns if Billy-Bob tries to take advantage of his monopoly by jacking up the price and then word gets around (perhaps through advertising) that there are noticeable advantages in the deals offered on Fords elsewhere. The bigger the price differential and the lower the transportation costs between seemingly distinct market areas, the larger the effective market area really becomes. Similarly, dealerships in Chevrolets, Plymouths, Volkswagens, Toyotas, Nissans, Volvos, Fiats, Hyundais, and Hondas are not selling exactly the same products as Ford dealerships (even Fords come in various models), but they sell very close substitutes for Fords that many buyers will turn to if the price of a new Ford at Billy-Bob's seems out of line. Used car dealers, estate sale auctions, bankruptcy liquidators and ordinary citizens selling their old cars through newspaper ads provide still other sources of supply for slightly less close substitutes for a brand new Ford. Even taxis, bus systems, rent-a-car agencies, subway systems, railroads, tractors, motorcycles, motorscooters, mopeds, bicycles, roller skates, dog-sleds and "shanks' mare" constitute partial substitutes for Ford ownership as a method of getting around from point A to point B and thus have a "competitive" restraining effect on pricing in the local market for Fords (which may be seen as only a part of some much broader market in means of personal transportation).

The bottom line -- competitiveness in markets is a matter of degree, and the observer's assessment of the degree of competitiveness in concrete instances will be heavily influenced by the observer's initial assumptions about the geographic extent of the market area and the breadth or narrowness of his definition of the good or class of goods that constitute equivalent products.

Monopoly

Literally, "single seller." A situation in which a single firm or individual produces and sells the entire output of some good or service available within a given market. If there are no close substitutes for the good or service in question, the monopolist will be able to set both the level of output and the price at such a level as to maximize profits without worrying about being undercut by competitors (at least in the short run). If demand for the good or service being sold by the monopolist is highly inelastic, prices and the rate of profit in the industry will tend to be higher (and output lower) than under competitive conditions and prices may in fact be noticeably higher than the marginal costs of production for substantial periods of time. To keep new competitors from entering the industry and flooding the market with additional supply in response to the unusually high rate of profit, monopolists historically have typically had to rely in the long run upon some sort of legal barriers to entry erected by government -- either an open grant of protected monopoly that legally forbids competitors to enter the market, or a regulatory regime that in practice makes it almost impossible for new competitors to meet required standards, or perhaps only such more transient barriers to entry as legally protected patent rights or copyrights for essential technology. However, see also entries under barriers to entry, cartel, natural monopoly and competition.

Demand

The willingness and ability of the people within a market area to purchase particular amounts of a good or service at a variety of alternative prices during a specified time period.

Demand, law of

Other things being held constant, the lower the price of a good (or service), the greater the quantity of it that will be demanded by purchasers at any given time.

Demand curve

A graphical representation of a demand schedule. Conventionally, the demand curve is usually drawn between axes with price plotted along the vertical axis and number of units of the good or service demanded plotted along the horizontal axis. Where the law of demand applies to the particular market under

consideration, the demand curve will slope (either gently or steeply) downwards from left to right.

Federal Reserve System

The central bank for the United States banking system and the institution that holds the primary responsibility for the making and execution of American monetary policies. Its bank notes circulate today as the United States' everyday paper currency. (Metal coins, however, are issued by the United States Treasury Department, not by the Federal Reserve.)

The Federal Reserve System represents an almost unique hybrid or blending of elements of governmental power with elements of private ownership and control. Because the authors of the 1913 legislation that set up the Federal Reserve System felt that it was vital to insulate monetary policy from "undue" pressure and influence by partisan politicians obsessed with their own short-range re-election prospects, the Federal Reserve was set up along the lines of an independent regulatory commission -- not as just one more agency of the Executive Branch that would be under the direction of the President and supervised closely by Congress. The private banking community was also given a major role in the running of the Federal Reserve System that continues to give banking interests privileged access to the process by which the US government's monetary policy is made.

The Federal Reserve System's highest decision-making body is its Board of Governors, which consists of seven members. Members of the Fed's Board of Governors are nominated for their positions by the President of the United States and then must be confirmed by a majority vote of the Senate before taking office. The members of the Federal Reserve's Board of Governors serve very long terms (fourteen years), and, once appointed and confirmed, they may not be removed from office by either President or Congress (except through a cumbersome process of impeachment by Congress for serious violations of the criminal law). People selected for appointment to the Board of Governors have nearly always been professional bankers, executives of Wall Street brokerage houses, or, occasionally, professional economists. They tend to share many of the relatively conservative political and economic views of the business and professional groups from which they are drawn. Because the President can not fire them from their

positions before their fourteen-year terms expire, members of the Board of Governors normally feel relatively free to ignore or oppose the President's preferences when they make U.S. monetary policies. Moreover, even though some members of the Board of Governors perhaps feel an ideological kinship or sense of political loyalty that might predispose them to support the policy views of the President who appointed them, the terms of the Governors are staggered, so that only one Governor's term expires every two years, making it unlikely that any President would be able to dominate the Board with a majority of his own appointees until near the end of his own second four- year term in office. (However, every four years, the President does at least get the opportunity to designate which one of the seven Governors will serve for the next four years as Chairman of the Board of Governors and exercize "moral leadership" as first among equals in the Governors' collective deliberations on monetary policy.)

Congressional influence on the Federal Reserve System's monetary policy decisions is also in practice rather limited. The Federal Reserve generates its own revenues to pay its expenses from fees paid to it by the commercial banks it regulates and from interest payments on the federal bonds, notes and bills that it holds as assets, so Congress lacks the normal leverage it has over other agencies through carrots and sticks brandished during the annual appropriations process. Of course, Congress, which created the Federal Reserve System by statute in 1913, has the constitutional power to alter or abolish the Federal Reserve system by a simple majority vote in both houses, subject to the possibility of a presidential veto, and the threat that Congress might actually do so if the Fed's policies contradict Congresssional preferences too seriously for too long undoubtedly induces a certain amount of responsiveness to Congressional jaw-boning by the Fed's policy-makers.

The Federal Reserve System presided over by the Board of Governors consists organizationally of 12 separate Federal Reserve District Banks -- each one located in and serving one of twelve geographical regions of the country. The district Federal Reserve banks are organized rather like private banking corporations whose shareholders consist of the private member banks in the district. But despite their semi-private character, the district Federal Reserve banks exercise Congressionally delegated legal powers to regulate the banking industry. Each district Federal Reserve Bank is managed from day to day by its own president,

who is elected to a 5-year term by his district Federal Reserve Bank's own individual board of directors. Two-thirds of the members of the district boards of directors are elected to their positions by the privately owned commercial banks in the district that are member banks of the Federal Reserve system. (Member banks are divided on the basis of their assets into "small", "medium", and "large" banks, with each category of banks allowed to elect two directors on a "one bank, one vote" basis.) The other one- third of the directors in each district are appointed from Washington by the Fed's Board of Governors, rather as though the Board of Governers were a major creditor or minority stockholder with guaranteed representation on the district boards.

The district Federal Reserve Banks act as non-profit "bankers' banks" -- that is, only commercial banking or depository institutions (and certain agencies of the federal government) maintain deposits at the Federal Reserve, and only member banking institutions and the US government are eligible to receive loans from it, not private citizens nor other kinds of non-bank commercial enterprises. All banks chartered as "national banks" by Federal law must be "member banks," that as such are obligated to maintain most of their reserves as deposits in their accounts at the Federal Reserve and to submit to detailed Federal Reserve banking regulations. Many state-chartered banks and thrift institutions nowadays also choose to be members of the Federal Reserve System and submit to its regulations in order to enjoy the valuable services which the Fed provides to them.

The district Federal Reserve Banks operate clearing houses for checks and bank drafts, issue new paper currency ("Federal Reserve notes") for sale to member banks on demand, withdraw worn-out currency from circulation, sit in judgment on the applications of banks that wish permission to merge with each other, extend "discount loans" to member banks (with the member banks putting up their own borrowers IOUs as collateral), and perform various miscellaneous regulatory functions pertaining to the banks in their districts. When the Federal Reserve System was originally created back in 1913, it was expected that the district Federal Reserve Banks would each pursue slightly different monetary policies, depending upon the economic conditions in their individual districts, so they were given the authority to collect a wide variety of information and statistical data on changes in regional business conditions to use in their decision-making. The high degree of integration of the national economy has for many years made it

impractical for the district Federal Reserve Banks to maintain different levels of interest rates or pursue differing policies regarding the growth or contraction of the money stock (these policy decisions are made centrally for the entire country by the Fed's Board of Governors in consultation with the district bank presidents), but the 12 district banks are still a major source of detailed economic data used by government policy-makers at both the national, state and local levels as well as by private economic forecasters and business executives.

The primary reason why the banking industry generally supported the creation of the Federal Reserve System and continues to support it today despite the inconveniences imposed by the Fed's regulations, is the valuable privilege that memberhip brings to the bankers to count on the Fed for large emergency loans of cash if they someday need it to survive a "run" on their bank. In a bank "run," large numbers of depositors frightened by rumors that their bank is about to fail suddenly begin crowding into the bank, demanding to withdraw all their deposits in cash. This exhausts the very limited cash reserves normally kept on hand in the bank's own vaults within a few hours. Since the large majority of the depositers' dollars on deposit are always out on loan to the bank's credit customers, and since it takes days or weeks to call in any sizable fraction of the loans outstanding, the bank would have to "go bankrupt" and be liquidated by the courts unless it can raise enough cash somewhere on short notice to pay off the panicky depositers demanding their money. This is where the Fed steps in as rescuing angel with armored cars full of cash pulling up to the beleagered bank within a few hours.

Bank runs are much more rare nowadays than they used to be, mainly because most depositers today feel much less reason to panic when they believe that they can get their money "for sure" -- either by virtue of the Fed's stepping in with loans in the case of a short-term "liquidity crunch" if the bank in question is relatively sound or (with more delay) by virtue of the insurance provided by the Federal Deposit Insurance Corporation if the bank really does turn out to be irretrievably in the red financially. And because runs are now both less likely to happen and less dangerous to the bank even if they do, bankers can earn higher profits by maintaining lower reserves than would otherwise be necessary and thus being able to lend out a higher percentage of their deposits at interest.

Because many bankers with the "king's X" of Federal Reserve and FDIC backing if they should get into difficulties might otherwise pursue excessively reckless

lending policies to increase their profits, the Federal Reserve's Board of Governors was given the power to set minimum reserve requirements for the member banks, to make regulations limiting the riskiness of banks' loan portfolios, and to send "bank examiners" out periodically to audit the books of member banks in order both to assure their compliance with regulations and to safeguard depositors' accounts against fraud or embezzlement by bank managers and employees.

The Fed's role as maker and executer of macroeconomically significant monetary policies for the United States government centers around three major policy tools at the Fed's disposal:

1. Manipulating the legally required reserve ratios ("reserve requirements") for banks (and, less directly, for some other depository institutions, such as savings and loans and credit unions)

2. Buying or selling U.S. government debt instruments (Treasury bonds, notes and bills) on the private financial markets in New York ("open market operations")

3. Setting the interest rate at which the Fed stands ready to make short-term loans to member banks and other depository institutions that would othertwise fall below the required reserve ratios (the Fed's "discount rate").

Using its discretionary power to manipulate these policy tools, the Fed is able to exercise substantial influence (but not complete control) over changes in the size of the money stock and thus over interest rates, thereby influencing overall levels of business activity and employment in the national economy (as well as indirectly influencing the rates at which the dollar is exchanged for foreign currencies and thus the flow of international trade and investment across U.S. borders).

The Fed's Board of Governors sets policies regarding reserve requirements and the discount rate all by itself, but changes in these two policy levers tend to be relatively infrequent (perhaps once or twice a year on average for the discount rate, and perhaps once every five to ten years on average for the reserve requirement). The Fed's main policy tool of choice for exerting its influence on the money stock and interest rates on a week-to-week basis is its "open market

operations." The necessary policy decisions about the Fed's on-going open market operations (buying or selling varying quantities of U.S. bonds and other treasury securities on the New York financial markets) are made for the Fed's Board of Governors by a slightly expanded body called the Federal Open Market Committee (FOMC). The FOMC consists of all seven members of the Board of Governors plus five of the 12 banker-elected presidents of the Federal Reserve district banks. (The president of the New York district bank is a permanent member of the FOMC, while the other 11 district bank presidents serve one-year terms on a rotating basis, with only four of them having the right to vote at any given time.) The FOMC meets rather frequently in Washington, DC, but it has also been the practice in recent years for the FOMC membership to convene informally via long-distance telephone conference calls or one-on-one communications with the Fed's Chairman on almost a daily basis.

Depression

A cyclical period of serious decline in the national economy, characterized by temporarily decreased levels of business activity across most economic sectors, and consequently by decline in Gross Domestic Product, relatively higher levels of unemployment, rising numbers of business bankruptcies and (at least in the most severe instances) a falling general price level (deflation). A general business slump of somewhat less severity and shorter duration is typically referred to as a recession. There is no precise dividing line that is generally recognized by economists to distinguish a recession from a depression, and incumbent policy-makers since World War II have almost always resisted describing their contemporaneous economic situation as a depression, preferring the milder sounding term "recession." The term "recession" has largely replaced the older and more emotion-laden term "depression" in most economic literature as well, except in referring to such catastrophic slumps of the past as "The Great Depression" of the 1930s.

In the United States, there is a highly respected private academic research foundation called the National Bureau of Economic Research that is the uncontested leader in the collection and analysis of extremely detailed data measuring multitudinous aspects of business activity. The NBER, after exhaustive research, periodically decrees the definitive dating of the latest periods of decline and recovery in the business cycle -- but unfortunately NBER's procedures are so

elaborate and so painstaking that recessions are nearly always clearly over by the time that NBER officially verifies that they have begun. Consequently, the NBER declarations are very useful for historians and economic theory-builders but definitely not for time-pressured policy- makers and journalists. While everyone is waiting for a definitive ruling by the NBER, there is a quick-and-dirty rule of thumb for identifying the onset of recessions that is almost universally employed by professional economists as a first approximation for policy purposes:

If inflation-adjusted Gross Domestic Product (or, alternatively, the closely related measure called Gross National Product) declines for two successive quarters (i.e., six months in a row), a recession has begun, and when inflation-adjusted GDP subsequently rises for two consecutive quarters, the recession has ended and recovery is under way.

Corporation

Also referred to as limited liability corporation. A type of legal entity provided for in the laws of most modern economically developed countries that two or more investors may agree to create for the purpose of combining some of their resources and going into business together. Corporations have the status of "artificial legal persons" and thus may own property, make contracts, be held responsible for committing crimes or torts, initiate court actions such as lawsuits, and so on. In the United States, businesses organized as limited liability corporations must indicate their status as such by including the word "Incorporated" ("Inc.") in the name of the firm. In other countries, the same purpose is served by using the equivalent abbreviations "Ltd." (Limited) or "S.A." (Anonymous Society) at the end of the company's name. It is today by far the most widespread and successful form of ownership of business property in all advanced capitalist countries.

The key feature of the modern business corporation that sets it apart from simple partnerships and sole proprietorships is that it provides the owners of the business with the important legal protection of "limited liability," whereas these other forms of business organization generally do not. If a failing business enterprise that is owned as a sole proprietorship or partnership is unable to generate enough money to pay its bills, the personal liability of the owners is unlimited -- that is, the unpaid creditors of the business can take legal action to seize not only any assets directly connected with the business itself but also the personal property of any individual owner as well, up to the full amount of the debt. But if a limited

liability corporation goes belly up, the legal claims of the company's creditors normally can extend only to the assets actually owned by the corporation in its own name, and not to the individually-owned property of the company's shareholders. The individual owner's shares in the corporation might become worthless if the business fails, but he or she does not have to worry about the Sheriff showing up to seize the house or the car or the family bank accounts to pay off the rest of what the company's creditors are owed.

Protection from personal liability makes it much safer and therefore more attractive for more individuals to use some of their savings to become part-owners of very large business organizations. Without limited liability, even the tiniest investment would put a shareholder's entire remaining fortune at risk. During the Middle Ages and the early years of the Industrial Revolution, the corporate form of ownership for business organizations was generally available only as a very special privilege occasionally awarded by the government to a handfull of royal favorites. But changes in the legal codes of Great Britain, the United States, France and other economically progressive countries during the 19th century removed most of the practical barriers to widespread adoption of the corporate form of ownership. This made it much easier to raise capital for new business enterprises. By allowing for pooling the savings of hundreds, thousands, or even millions of individual investors at manageable levels of risk, the widespread adoption of the corporate form of business ownership made extremely large scale private investment projects practical for the first time in history, thereby contributing greatly to the modern era's historic surge in economic growth that continues up to the present day.

Derived demand

The demand for each of the factors of production is often referred to as a "derived" demand to emphasize the fact that the relationship between the factor's price and the quantity of the factor demanded by firms employing it in production is directly dependent on consumer demand for the final product(s) the factor is used to produce. If for some reason (say, for example, a spontaneous shift in consumer tastes) the demand for men's hats increases (shifts to the right) so that more hats than before can be sold at any given price, then the "derived" demand for felt used in making hats will also increase (shift to the right) so that felt-makers will be able to sell more felt at any given price. (We would also expect the

hat-makers' demand for the labor of hatters and for specialized hat-making machinery to shift to the right in a similar fashion in response to the public's greater demand for hats.)

What is the mechanism by which a shift in demand for the final product is translated into a shift in demand for the factors of production used in its manufacture? The key is the change in the price of the final product brought about by the shift in demand for it. If the demand curve for hats shifts to the right and the (upwardly sloping) supply curve remains unchanged, then the equilibrium price and quantity in the hat market will now involve both a somewhat higher price for hats and a somewhat larger quantity of hats being produced and sold to the public. (Because of the price rise, the marginal revenues earned by the manufacturers per additional hat sold will be higher, so consequently their desire to maximize profits will lead them to produce additional hats until the marginal cost for the last hat rises to equal the new higher price.) But producing more hats than before will require more of the relevant factors of production than before, which they will want to purchase from their suppliers, shifting the demand curves for each of the factors to the right. (This increase in demand for the factors in turn will tend to raise the factor prices somewhat and to increase the quantity of them sold, which then affects the factor producers' demand for their own necessary inputs and brings about further price-and-quantity adjustments throughout the economy in an ever-widening ripple effect.)

Division of labor

The division of a complex production process into a number of simpler tasks, each one of which is undertaken by a different individual who typically (but not necessarily) specializes in one task (or a very few tasks) on a more or less permanent basis. The advantages of division of labor for enhancing human productivity were first extensively analyzed by Adam Smith in his 1776 classic The Wealth of Nations, where he coined the phrase. Whereas Smith's famous analysis of the pin factory emphasized improvements in technical efficiency (the time and physical movement saved by workers no longer having to switch from one operation and set of tools to another), it also took note of the improvements in allocational efficiency made possible by developing and then taking advantage of workers' differing skills and talents according to the (at that time not yet named) principle of comparative advantage.

In the broadest sense, the extension of the division of labor is the fundamental feature of a modern or developed economy, in which gigantic increases in the volume and variety of production have been attained -- but at the cost of massively increasing economic interdependence within larger and larger populations spread over larger and larger geographical areas. In such a complex society, instead of each individual or family attempting to produce all or most of what it consumes, the individual specializes in producing only a few kinds of good or service (or perhaps only small components of a single good or service) and then acquires all other desired goods or services from the production of other specialists by means of mutual exchange (or, in non-market economies, perhaps through coercive or customary transfer).

It is worth noting that, while economists tend to emphasize the immense production- and efficiency-enhancing effects of a complex, geographically extensive, and highly specialized division of labor and the markedly higher average standard of living it makes possible, anthropologists, sociologists, and social-psychologists (as well as many philosophers, artists and social theorists) tend to focus more on other presumed non-economic side-effects of greater social differentiation that they typically view in a much more negative light -- such as the development of a diminished sense of wholeness or personal authorship that may result in lessened emotional satisfaction from one's work; greater difficulties in generating agreement on moral principles and a sense of social solidarity or "belongingness" when the far-flung members of society live their lives in such varied ways and develop such diverse interests; the insecurity of the individual's social status when people are no longer assigned their place in society but must continually compete with others to retain or improve their own social positions; the loss of the sense of community mastery over one's fate that comes with dependence upon distant and unknown people for the provision of most of one's vital necessities, and so on. Analyzing and critiquing the many consequences of an advanced and highly specialized division of labor is among the central themes in the works of such pioneer modern social theorists as Jean-Jacques Rousseau, Karl Marx, Ferdinand Toennies, Henry Maine, Max Weber, and Emile Durkheim, to mention only a few, and these same topics still remain central to much of contemporary social thought. [See: socialism].

Gross National Product (GNP)

An estimate of the total money value of all the final goods and services produced in a given one-year period by the factors of production owned by a particular country's residents. ("Final" goods and services means goods and services sold or otherwise provided to their final consumers -- that is, to avoid double counting, the value of steel sold to GM to make a car is not added separately into the GNP or GDP totals because its value is already included when we add in the final sales price of the car to the customer.)

GNP and GDP are very closely related concepts in theory, and in actual practice the numbers tend to be pretty close to each other for most large industrialized countries. The differences between the two measures arise from the facts that there may be foreign-owned companies engaged in production within the country's borders and there may be companies owned by the country's residents that are engaged in production in some other country but provide income to residents. So, for example, when Americans receive more income from their overseas investments than foreigners receive from their investments in the United States, American GNP will be somewhat larger than GDP in that year. If Americans receive less income from their overseas investments than foreigners receive from their US investments, on the other hand, American GNP will be somewhat smaller than GDP.

Equivalent estimates of GNP (or GDP) produced in a given year may theoretically be arrived at through at least three different accounting approaches, depending upon whether the transactions that determine the prices of final goods and services are looked at and tallied up by focussing on the buying or by focussing on the proceeds from selling or by focussing on the nature of the products themselves. Using the expenditure approach, you can estimate total GNP as the sum of estimates of the amounts of money that are spent on final goods and services by households (Consumption), by business firms (Investment), by government (Government Purchases), and by the world outside the country (Net Exports). Using the incomes approach, you can estimate total GNP by summing up estimates of the different kinds of earnings people receive from producing these same final goods and services:

Total wages and salaries Profits of incorporated and unincorporated businesses Rental incomes

Interest incomes

(Plus certain adjustments to account for wear and tear on productive assets like plant and machinery -- depreciation -- and what are called indirect business taxes). Using the product or output approach, you can estimate GNP by summing up the output of all the various organizations producing goods and services in the country, subtracting out the costs of their raw materials to avoid double counting and making suitable adjustments for depreciation and for the value of imports and exports. (In theory, all three approaches should give you the same grand totals -- but of course in actual practice there will be discrepancies, and sometimes sizable discrepancies, between the three estimates.)

Why does anyone bother to estimate the GNP or GDP? For the same reasons statistical data is also gathered on unemployment rates, consumer price levels, the international trade balance and so on -- to facilitate economic policy making by government, to assist in planning by decision-makers in private business, and to test economic theories. If government policy makers include among their goals the promotion of economic growth and material prosperity in the national economy as a whole by means of monetary and fiscal policy, they need to have some reasonably precise way of telling how the economy is doing so as to decide whether they should be pushing on the gas or stepping on the brakes. Businessmen responsible for planning new investments in plant and equipment or the introduction of new products can use macroeconomic data and economic theory to forecast the likely levels of demand for their products and the probable trends in their various costs of production. Finally, a historical record of such statistics provides economists with the necessary data to test and refine their theories about how the economy actually works (and, in the process, perhaps to improve the policy makers' understanding of the likely consequences of their policies).

GNP and GDP are among the most comprehensive measures of the overall amount of economic production taking place in a national economy. Nevertheless, the available statistics produced by government agencies are always far from perfect estimates of what they purport to measure. They are measured in money value terms to get around the problem of adding up total output of many different goods and services that are normally expressed in many different kinds of incomparable physical units. Microeconomic theory gives us lots of reasons for

believing that the relative prices at which products trade on a free market represent reasonably unbiased estimates of the relative values consumers put upon the various kinds of goods and services traded -- at least where there are no large problems with externalities or public goods. But not all the final goods and services produced in a society are traded on the free market, and the relative contributions of these untraded goods and services to the consumers' material living standards are therefore awfully difficult to estimate very well. Most of the services produced by government, to take the largest example, cannot be valued at a free market price because they are not offered for voluntary purchase on a free market -- instead, the presumed beneficiaries of these services (the citizenry) are forced to pay for them through taxes, whether they think the benefits are "worth it" or not. In compiling the national accounts, the government statistical offices simply make the heroic (and self-flattering) assumption that all the goods and services provided by government are "worth" at least what was spent to produce them, however outrageous the costs might have been and however worthless (or harmful) the output might have been in the eyes of the citizenry.

A very large category of privately produced goods and services whose production does not register at all in the official GNP or GDP statistics (because they do not trade for money on the market) consists of householders' home production for their own use -- things like backyard vegetable gardening, do-it-yourself home and auto repairs, and the innumerable productive service activities of homemakers in cooking, cleaning, sewing, childcare and so on. Another major omission from the national accounts consists of goods and services that actually are traded for money on markets -- black markets -- but the transactions are deliberately concealed from government information collectors, either to avoid prosecution for trading in illegal demerit goods (for example, drugs and prostitution) or simply to avoid paying taxes or submitting to costly regulations on otherwise potentially legal business transactions (working off the books, unauthorized import/export trade, "moonshine" production of liquor, etc.). Economists' unofficial estimates of the size of the American "underground economy" in recent years range from no less than 5% to as much as 30% of official GDP!)

If one wants to use GNP (or GDP) to measure changes in overall levels of economic production from one year to the next, then using money prices as a "common denominator" for adding up all the disparate kinds of goods and

services introduces another problem for the accuracy of the estimates -- inflation. Using money valuations to measure output at several points in time is a little like using a rubber tape-measure to measure several different distances. Part of the increase in GNP (or GDP) from one year to the next really is the result of increased output, but part is also likely to be due merely to change in the value of the currency unit used to measure it. Government statistical compilers try to deal with this problem by producing estimates of "real" or "constant dollar" GNP (and GDP), dividing their original ("current dollar") estimates by one or another of many possible "price indexes" constructed to account for and remove the effects of general price inflation -- but the problems of choosing and constructing appropriate price indexes for this purpose are themselves numerous and admit of no single unambiguous "best" answer to the problem.

It is also important to keep in mind that GNP and GDP (even when divided by the size of the population to produce "per capita GNP") were never intended even theoretically to be good measures of overall economic welfare: they are at best only measures of recent levels or rates of productive activity. Overall societal welfare is a broader concept than just economic welfare, and GNP (or GDP) is at best only a very incomplete measure even of economic welfare, since levels of current production do not necessarily reflect the levels of accumulated wealth actually at the disposal of the citizenry. Moreover, the greater availability of leisure time made possible by today's higher levels of productivity is pretty clearly an improvement in our economic welfare over the days of the early 19th century 14-hour workday. But this improvement does not show up at all in our long-term GNP growth rates -- except possibly in a backwards way, since our official GNP would no doubt be much higher than it is today if everyone still worked a 14-hour workday using our modern technology instead of "wasting" all those potential labor hours on "nonproductive" recreation, relaxation, contemplation and socializing. And of course aggregate GNP and GDP do not give any indication as to who gets to consume how much of the goods and services produced, nor do their compilers exercise any "judgment" about what these goods and services are or ought to be (as the advocates of the "equitable distribution" and merit goods and demerit goods concepts would want to insist upon as crucial determinants of societal welfare).

Gross Domestic Product (GDP)

An estimate of the total money value of all the final goods and services produced in a given one-year period using the factors of production located within a particular country's borders.

Economics

The branch of the social sciences concerned primarily with analyzing and explaining human behavior in making decisions about the allocation of scarce resources. Economists study the complex ways in which the following are determined within a society:

1. What goods and services are to be produced (and in what amounts)? 2. By what means are these goods and services to be produced (using what

combinations of the various substitutable factors of production)? 3. How are the goods and services that are produced to be distributed among

the individual members and groups in the society's population?

Egalitarianism

A social philosophy or ideology placing primary stress on the value of human equality and advocating radical social reforms so as to eliminate all forms of economic, social and political inequality.

Factors of production

The scarce resources that are useful not so much for direct and immediate satisfaction of human wants as for producing other goods or services. Economists often find it useful for purposes of theoretical simplification to group the millions of different sorts of factors of production into several very broad categories and then discuss them as though all the items within each category were perfectly substitutable for each other and therefore traded on a single market. The simplest such conventional categorization of the factors of production divides them into land, labor, capital, and sometimes also entrepreneurship and/or human capital.

Fiscal policy

That part of government policy which is concerned with raising revenue through taxation and with deciding on the amounts and purposes of government spending. Keynesian economic theorists believe that government can, and should, regulate

the overall pace of activity in the national economy through fiscal policy, principally by deliberately having government borrow to spend more than it takes in (running a budget deficit) to increase total demand for goods and services in times of high unemployment and economic slowdown (the deficit being created either by cutting taxes or by increasing spending or both). Similarly, Keynesian theorists would advocate having government spend less than it takes in (running a budget surplus) to cool down the national economy when too great an expansion of total demand has pushed production to its physical limits and threatens to bring on excessive inflation.

Free trade

A legal arrangement or national policy under which the exchange of goods and services across international borders is neither restricted nor subsidized by techniques of government intervention such as import tariffs, import quotas, export subsidies, discriminatory regulations disadvantaging foreign buyers or foreign sellers, trade embargoes, political manipulation of foreign currency exchange rates, and the like. From their first origins in the writings of Adam Smith up to the present, the classical and neoclassical schools of economic theory have emphasized the advantages of free trade policies and the disadvantages of protectionism for the improvement of popular living standards and the promotion of overall rates of economic growth.

Although the theoretical arguments can and do become extremely detailed and complex, the basic conclusion of classical and contemporary neoclassical economic theory is that the advantages of free international trade represent basically only a special case of the advantages of the free market system in general. Although moving toward free trade may represent very real financial losses for the small minority of companies with the political influence to get themselves protected from foreign competition, these losses are normally much more than counterbalanced by the gains to the great majority of the population. Free trade leaves the country's consumers free to seek out the best bargains they can find by not arbitrarily restricting their ability to choose foreign suppliers when they offer a better deal than their domestic competitors in terms of price and/or quality. This enhances competition and breaks down local monopolies. Free trade also enhances the profitability of many other local industries by enabling them to shop around for better deals in purchasing their supplies of raw materials and

other capital goods and thus helping them to reduce their costs of production. In the most general terms, free trade makes possible a progressive extension of the area within which specialization and the division of labor takes place according to the principle of comparative advantage, producing gains from trade in overall productivity and economic efficiency that result in higher average living standards both at home and abroad.

Labor

The collective or generic name given to all the various productive services provided by human beings, including physical effort, skills, intellectual abilities and applied knowledge. Although a market society with a complex division of labor involves hundreds or even many thousands of discrete types of labor differentiated according to the kinds of skills and abilities required (each with their own separate but interconnected labor markets), economists often find it useful for theorizing to simplify the real situation by speaking as though there was only one homogeneous kind of labor to be considered, with this single factor of production being freely and easily substitutable across all different alternative production processes for all different sorts of goods and services. When economists moving beyond such very simple models of the economy want to recognize the reality that acquiring specialized labor skills involves a process of specialized learning that is often very costly and time-consuming, they are apt to refer (somewhat contradictorily and confusingly) to "investment in human capital" and treat the individual's process of decision-making in deciding what sorts of training to pursue according to a marginal costs of production and marginal revenues logic analogous to firms' decision-making processes in choosing to invest in physical capital.

Human capital

A loose catch-all term for the practical knowledge, acquired skills and learned abilities of an individual that make him or her potentially productive and thus equip him or her to earn income in exchange for labor. The figurative use of the term capital in connection with what would perhaps better be called the "quality of labor" is somewhat confusing. In the strictest sense of the term, human capital is not really capital at all. The term was coined so as to make a useful illustrative analogy between investing resources to increase the stock of ordinary physical

capital (tools, machines, buildings, etc.) in order to increase the productivity of labor and "investing" in the education or training of the labor force as an alternative means of accomplishing the same general objective of higher productivity. In both sorts of "investment," costs are incurred by investors in the present in the expectation of deriving extra benefits over a long period of time in the future. As in the case of ordinary investments in physical capital, investments in human capital make economic sense to the extent that the value of the additional future benefits to be expected (greater productivity and thus more income for the worker and his employer) exceed the extra costs that have to be incurred in the present to obtain them (costs of schooling or training programs, production and income foregone while the individual is in training, the loss of leisure and perhaps the experience of mental anguish undergone by the individual in having to learn new things, etc.). Varying levels of past investment in human capital provides one of the main explanation for the size of wage and salary differentials among individuals: payment for an individual's labor in reality includes not just payment for the employee's leisure time foregone but also a premium that represents the going rate of return on his past investment in human capital.

The analogy between human capital and real capital breaks down in one important respect, however. Property rights over ordinary inanimate capital are normally readily transferable by sale from one owner to another, and consequently markets for capital goods can function easily and smoothly to reallocate such resources from one project to another with minimal complications and transactions costs. The value of resources that have been invested in physical capital by an investor can often be readily recovered later (at least in good part) through resale, with the proceeds being easily redeployed into purchases for consumption or reinvestment in other types of capital goods as the investor may choose. However, human capital is by definition inseparably embedded in the nervous system of a specific individual and it thus cannot be separately owned apart from the individual's living body itself. Except in societies that legalize slavery (or at least enforce very long term transferable indentured labor contracts), human capital itself cannot be directly bought and sold on the market -- only its temporary services as reflected in the labor productivity of the one individual who alone can own it. If an employee chooses to quit his or her job (perhaps because of an offer of much higher pay by a competing firm in the same industry), then any past investment

the employer may have made to upgrade the employee's job skills is lost to the firm from the minute the former employee walks out the door for the last time. The only person who can invest in human capital with full confidence that he will not be arbitrarily deprived of its fruits in the future without compensation is the individual in whom the investment is made, so other firms or individuals therefore have much less incentive to invest resources in him or her in this way, even if this might be the cheapest way to increase productivity. Even the individual in whom the human capital is to be embedded may be somewhat deterred from investing by the fact that such an investment is necessarily very illiquid -- that he cannot later recoup any part of the value of his own investment in human capital by selling it off if he should desire to go into some other line of endeavor where the skills involved are not useful.

Impoundment

A traditional budgeting procedure by which the President of the United States once could prevent any agency of the Executive Branch from spending part or all of the money previously appropriated by Congress for their use. He would accomplish this, in essence, by an executive order that would forbid the Treasury to transfer the money in question to the agency's account. (The Constitution provides that no money from the Treasury can be spent without a specific Congressional appropriation, but it is silent on the question of whether all money appropriated by Congress actually has to be spent.) All American presidents since John Adams asserted the right to impound appropriated funds, and presidents often used this as a way of making relatively small cuts in Federal spending on programs that they deemed unwise or unnecessary, despite occasional murmurings of dissatisfaction from Congressmen annoyed by the cancellation or trimming of some of their pet pork-barrel projects. In 1973-1974, however, President Nixon made unusually large-scale use of impoundment in his efforts to fight the unusually serious inflationary pressures of the time by trimming back the budget deficit. President Nixon impounded nearly $12 billion of Congressional appropriations, which represented something over 4% of the spending Congress had appropriated for the coming fiscal year. Congressional leaders, who were already up in arms against the Nixon White House because of the Watergate scandal, rebelled against the implicit presidential rebuke of their judgment and authority over spending decisions posed by such large-scale impoundment. In

1974, Congress passed legislation purporting to make the old practice of presidential impoundment illegal and legally requiring the Executive Branch to spend every last penny that would ever be appropriated for it by Congress in the future. The administration denied that Congress had the constitutional authority to over-ride the President's control over the executive branch agencies in this manner, but a Federal Court eventually upheld the Congress's position on this matter, and the new Ford Administration chose to acquiesce in this lower court ruling rather than to further antagonize the already hostile Congress with an appeal to the Supreme Court.

Inflation

In contemporary usage, a sustained rise over time in the general level of prices, normally measured by a weighted index of prices of a large and representative sample of goods and services (both consumers' goods and producers' goods) regularly traded in the economy under consideration. (In 19th century usage, the term referred more specifically to any sustained expansion in the stock of money available within the economy under consideration -- the eventual consequence of which would normally be a generalized increase in prices.)

When the quantity of money available in the economy begins to exceed the amount that firms and households (in the aggregate) feel they wish to keep on hand to finance their expected volume of trading in the foreseeable future, people tend to increase their rate of spending all at once, shifting the demand curves for nearly all goods and services to the right at the same time and thus driving up the general price level -- which is just another way of saying that each unit of money begins to be worth less than before in its purchasing power. Such an acceleration of spending may happen for any of a number of reasons:

1. The money stock itself is rapidly expanding 2. The available stocks of many goods have suddenly shrunk dramatically

due to natural disaster, wartime destruction, or political interruption of established international trading relationships through embargoes or blockades

3. The average amounts of money people want to keep on hand is shrinking due to rising guesstimates of what future inflation rates might be

4. Increasing availability of new close money-substitutes like credit cards, or

5. because households' willingness or ability to save is for some reason sharply decreasing.

History strongly suggests, however, that sustained inflation at rates of more than four or five percent per year in "normal" times is nearly always due primarily to government or central bank policies of rapid monetary expansion rather than to anything else that may be going on in the private sector to influence the public's demand for cash balances.

If the money stock continues to increase a great deal faster than the public's total demand for cash holdings, the inflationary process begins to feed upon itself. Initial experience with accelerating inflation quickly convinces the public that the future purchasing power of their money holdings is going to be very much less than it is in the present -- leading people to reduce still further their desired amounts of money to hold and further accelerating the general rise in prices because of their desperate efforts to spend away their money as quickly as possible, before its value melts away. When such an inflationary panic once takes hold, the result is apt to be hyperinflation, in which prices may begin increasing by several hundred percent (or even several thousand percent) per month until the monetary system collapses altogether and people resort to primitive barter (or the use of more stable foreign currencies, if available) rather than accept the government's worthless money as payment for their goods or services.

Interest rate(s)

The price(s) of obtaining the temporary use of money that one borrows from someone else who actually owns it, normally expressed as a percentage of the amount borrowed per year. Since loans and loan repayment extend over considerable periods of time and entail more complex security arrangements than a simple cash-on-the-barrelhead exchange, interest rates to be paid are normally spelled out as part of a relatively complex written contract between borrower and lender. Like most other prices in an advanced market economy, the going levels of interest rates are determined in rather well-developed, highly competitive markets (in this case, they are referred to as "credit markets" or "financial markets") by the interaction and mutual adjustment of supply and demand. The demand for loanable funds mainly comes from firms who need them for investment purposes, from households who want them mainly for the purchase of

big-ticket consumer durable goods like houses or autos, and from national, state and local governments who want them in order to make up the difference between the amount of money available in the treasury from tax collections and the (larger) amount of money the government has nevertheless decided to spend in financing its various projects and programs. The supply of loanable funds comes mainly from individual household and business firm savings placed with financial intermediary firms such as banks, thrift institutions, and insurance companies or else mobilized directly from individual lenders through the issuance of bonds, notes and other credit instruments tradeable on financial markets. In economies such as our own that allow fractional reserve banking, a considerable portion of the supply of loanable funds comes through credit creation by the central bank and the banking system. It is a serious oversimplification to refer to "the" rate of interest because at any given time there will normally be a whole range of different rates of interest that vary according to (among other things) the particular form of lending (bank savings deposits, personal i.o.u.'s, secured mortgages, collateralized bank loans, corporate bonds, U.S. Treasury notes, etc.), the contractual terms upon which the money is loaned (duration of the loan, repayment schedule, fixed rate or floating rate, national currency in which the loan is to be repaid, etc.), and the perceived degree of risk that the particular category of borrower will default on his repayments. For theoretical or analytical purposes, economists often like to postulate the existence of a "pure" (completely risk free) rate of interest (closely approximated by the rate of return on very short-term U.S. government Treasury bills) and then analyze other real world interest rates in terms of various factors peculiar to particular types of loans that each cause some sort of "premium" to be added on to the pure rate of interest in proportion to the various kinds and degrees of risk entailed (risk of default, risk of inflation or currency devaluation reducing the real value of the repayment over time, risk that the debt would be hard to resell if the lender unexpectedly needs to get his money out before the term of the loan expires, etc.)

The level of interest rates plays an extremely important role on either the supply side or the demand side of very many other important markets in the economy, and for that reason interest rates are often perceived by government policy makers as a potentially powerful tool for manipulating the economy in the interests of promoting growth, controlling inflation, stimulating exports and so on. Large-scale investment projects by business firms such as building new factories (or

starting up new businesses) are often financed largely by borrowing, and the level of interest rates plays an important role in determining whether a particular investment project under consideration seems likely to be profitable or not. Thus, a period of very high interest rates (especially very high long-term interest rates) is likely to reduce greatly the amount of new investment undertaken -- with obvious short-term consequences for the level of employment in the construction and machine-tools industries and with longer-term consequences for the country's overall economic growth in the future. Similarly, the level of interest rates plays a large role in the willingness and ability of consumers to purchase new houses, recreational vehicles, automobiles, refrigerators and other big ticket items -- with important implications for the profitability and level of employment in these industries. Interest rates available on savings accounts, bonds, and the like play a role in determining household decisions about how much income to save and how much to spend on immediate consumption. Interest rates (and especially their relationship to the levels of interest rates in other countries) also play a crucial role in affecting the volume of savings entering the country from abroad for local investment or leaving the country for foreign investment purposes -- thus influencing not only investment activity but also the exchange rates of the domestic currency in relation to foreign currencies, and thus the attractiveness of the country's exports to potential purchasers abroad. For all these reasons (and others), governments in the 20th century are nearly always deeply involved in deliberate efforts to influence interest rates by means of monetary policies that encourage the expansion (or, occasionally, contraction) of the money stock through regulatory pressures on the banking system.

Investment

All income expended by firms or government agencies on capital goods for use in their productive activities. Thus aggregate investment in a national economy is the total amount of spending in order to maintain or increase the stock of physical goods not intended for immediate consumption by the purchasing entity but rather for use in producing other kinds of goods or services to be delivered to others. (Note that the economist's sense of the term is somewhat narrower than the general population's use of the term, in that the economist would exclude the purchase of purely financial paper assets like bonds or shares of stock from

coverage by the term "investment.") All forms of investment thus require prior saving from income, but not all savings are for the purpose of investment.

Macroeconomics

The subdivision of the discipline of economics that studies and strives to explain the functioning of the economy as a whole -- the total output of the economy, the overall level of employment or unemployment, movements in the average level of prices (inflation or deflation), total savings and investment, total consumption and so on. The focus of much of macroeconomic theory is analysis of the ways in which conscious government policies (and the unintended secondary consequences of these policies) can influence the overall "economic health" of the country for good and for ill.

Market economy

An economy in which scarce resources are all (or nearly all) allocated by the interplay of supply and demand in free markets, largely unhampered by government rationing, price-fixing or other coercive interference. In classifying real historical economies, the level of "marketization" is not primarily an either/or issue but rather a matter of degree. The greater the proportion of the goods and services produced in the society that are allocated by market processes (rather than by government edict or the operation of unchangeable custom), the more meaningful it is to refer to its economy as a market economy -- and the more useful is the abstract economic theory of the operation of markets likely to be for understanding and even predicting economic behavior within that society.

Probably the most critical single distinction between "basically market" and "basically non-market" (socialist, feudal, hunter-gatherer, etc.) economies is whether or not the determinations of what is to be produced and of the corresponding allocation of producers' goods (land, raw materials, machinery, and other "capital," as well as the services of labor) are accomplished primarily through free markets rather than primarily through government command or unalterable custom.

The concept of a market presupposes the existence of certain sorts of property relations in the society involved. At least some goods and services must be legally

or socially regarded as alienable property -- that is, there must be ascertainable individuals (or group representatives) who are recognized as having not just the right to use particular scarce economic resources for their own purposes but also the discretionary authority permanently to transfer such rights of use to someone else in exchange for some mutually agreeable quid pro quo, such as money or other goods or services. Not all human societies have recognized any such rights to transfer ownership, and most historical human societies have forbidden or placed stringent limits on the transferability of at least certain kinds of recognized property rights. In many societies (including most of Europe during the Middle Ages), individual or family rights to the perpetual use of particular plots of land were well established and protected by law -- but such rights only rarely could legally be sold to someone else because the land was socially regarded as fundamentally the inalienable property of either the local community as a whole or of the tribe or clan or church or perhaps of the reigning royal family. And even in the USA since 1865, while each person's ownership of his or her own body is well established, the law will still not allow you to make a binding contract to sell yourself into slavery or even to auction off your spare bodily organs for purposes of a surgical transplant.)

It is worth noting for clarity's sake that the concept of a market does not logically presuppose the existence of "private property in the means of production" in the sense that private individuals or family households are the owners of land and capital and thus the recipients of profits, interest, rent etc. One may at least theoretically conceive of an economy of market socialism, in which workers' collectives, consumers' cooperatives, village communes or even autonomous state agencies leased from the state or held actual title to land, mines, factories, machinery and so forth -- so long as the socialist production organizations were free to buy and sell their output and and the use of their assigned land or capital assets to each other at freely negotiated prices responsive to conditions of supply and demand (assuming, of course, they are allowed to keep effective control of the bulk of the proceeds). There are, of course, both theoretical and practical problems with market socialism, and the costs and benefits of capitalist markets cannot be uncritically attributed to such a system. The larger point is that socialist economies have historically included varying proportions of "remnant" market elements in their make-up, and the theoretical possibilities for additional "hybrid" forms are numerous.

Microeconomics

The subdivision of the discipline of economics that studies the behavior of individual households and firms interacting through markets, how prices and levels of output of individual products are determined in these markets, the interconnections by which different markets affect each other, and how the price mechanism allocates resources and distributes income.

Money stock

(Also sometimes loosely referred to as the money supply, a term that, strictly speaking, should be reserved for the entire supply schedule of associated interest rates and the quantities of money that would be created at those rates.) The money stock is the total amount of money available in a particular economy at a particular point in time. Since many different things may serve more or less well as money (or close money substitutes), and since several different sorts of things may be serving as money at the same time in any particular economy, precise definition and measurement of the money stock presents some serious practical problems for the policy maker who wishes to use manipulation of the growth (or contraction) of the money stock as a tool of economic policy.

The narrowest definition of the money stock in common use by the advanced industrial countries today ("M1") includes only the paper currency and coinage in circulation among the public plus the total balances instantly available to depositors in privately held checking accounts ("demand deposits" or "sight deposits") in the country's commercial banks and similar depository institutions (like savings and loans, credit unions, etc.). (A very large proportion of checking account money, of course, is simply created by the banks themselves as they extend loans to borrowers by simply crediting their borrowers' checking account balances with the amounts loaned). Travelers' checks are also included in M1 in some countries, including the US.

"M2," the next broadest measure of the money stock, adds on to the totals included in M1 the total amount of deposits in short-term savings accounts and small certificates of deposit. There are a number of still broader definitions of the money stock ("M3," "M4," "L," etc.) that go on to add in such only slightly less liquid money-like assets as checkable money market mutual funds, larger

denomination bank certificates of deposit, credit card credit limits, pre-approved lines of credit, and so on.

Supply side economics

A school of thought within the economics profession emphasizing that the main source of a country's economic growth is constant improvement in the efficiency with which resources are allocated for production. While the policy recommendations of the rival Keynesian school tend to focus almost entirely on what government can do to stimulate or restrain aggregate demand in the short-run so as to even out the business cycle, supply-side policy analysts focus on barriers to higher productivity -- identifying ways in which the government can promote faster economic growth over the long haul by removing impediments to the supply of, and efficient use of, the factors of production. Supply-siders believe that unwise provisions of the tax laws (and especially high marginal rates of personal and corporate income taxation) produce very damaging incentives that lead people to work less and to invest less (and to do both less efficiently) than they otherwise would. Supply-side policy recommendations typically include deregulation of heavily regulated industries, promotion of greater competition through lowering protectionist barriers to international trade, and measures to repeal special subsidies and tax loopholes targeting particular industries in favor of lower and more uniform tax rates across the board. Supply-side economics became particularly well-known to the general public during the 1980s because of its advocacy by one influential faction of economic policy-makers in the Reagan administration, leading to the use of the term "Reaganomics" to denote many of the ideas of the supply-siders. Supply-siders played a much smaller role in economic policy-making under the Bush administration, as the focus of attention shifted toward controlling the size of the budget deficit and away from the earlier "Reaganomics" preoccupation with accelerating the country's rate of economic growth.

Regressive tax

A tax that tends to take a larger percentage of the incomes of lower income citizens than it takes from the incomes of higher income citizens. Examples: a poll tax, a flat percentage tax on only the first so many dollars of income (like the

social security tax) or a sales tax on consumption items of common necessity (like groceries).

Progressive tax

A tax that tends to take a smaller percentage of the incomes of lower income citizens compared to the percentage it takes of the incomes of wealthier citizens. Example: an income tax with steeper rates for those in higher income brackets, or a special sales tax levied only on expensive “luxuries” like yachts or jewelry.

Tax, taxation

A compulsory transfer of money (or occasionally of goods or services) from private individuals, institutions or groups to the state. The amount and timing of the levy exacted from the individual taxpayer may be determined on the basis of any of a very large number of factors, but historically the most common sorts of tax have been levied based on the wealth or the income or some other characteristic of the particular taxpayer at a given time ("direct taxes" like income tax, social security tax, real property tax, estate tax, poll tax, business or professional license fees) or as some form of compulsory surcharge on one or more types of private trade or other voluntary transactions ("indirect taxes" like general sales taxes, specialized excise taxes, import tariffs, marriage licenses, and so on). In addition to the obvious function of raising revenue to finance government purchases of goods and services or income transfer programs, taxation may also be used deliberately as a policy instrument by which government seeks to influence the behavior of various segments of the citizenry by raising the costs of choosing to engage in the kinds of behavior on which taxes are imposed -- the classic examples being "sin" taxes to discourage consumption of tobacco and alcohol or protective import tariffs imposed to discourage the purchase of foreign-made products. (Of course, all forms of taxation will have an impact on the incentives facing the citizenry and thus will affect their behavior -- but frequently these non-revenue effects will not have been analyzed in advance and therefore do not represent deliberate policy. Legislators are rather regularly astonished by the unexpected -- and often negative -- secondary effects of their enactments, such as cigarette tax increases in New York producing diminished revenues due to increases in smuggling of cheap untaxed cigarettes, or newly

imposed luxury taxes on yachts meant to soak the rich creating mass blue-collar unemployment in the boat-building industry due to greatly diminished sales.)

Right-to-work laws

State laws that make it illegal for labor unions and employers to enter into contracts that provide for a business to employ only union members in the jobs covered by the contract. One typical version of a right-to-work law reads “No person may be denied employment, and employers may not be denied the right to employ any person, because of that person's membership or non-membership in any labor organization.” Labor union leaders typically seek the repeal of right-to-work laws because much lower percentages of workers choose to join unions and pay dues in states where such laws are in effect. Defenders of right-to-work laws tend to argue that workers who refuse to join unions mainly do so because they just do not value the collective bargaining services that unions perform and/or because they disagree with the political causes that unions support with their dues money. Opponents of right-to-work laws tend to see refusal to join a union mainly as attempting to be a free rider who enjoys the very real benefits of union representation without having to pay his fair share of the cost. About 20 US states have some version of such a law presently in effect.

Price controls

A form of government intervention in the economy in which a government agency uses its law-making power to regulate the prices at which otherwise voluntary private exchanges may take place. The government agency may attempt to fix and enforce the exact prices at which a particular good or service may be sold (as for example when state regulatory commissions fix the rates for electricity, gas or water to be sold by monopoly utility companies in particular geographic areas). Alternatively, the government agency may be content to set “ceiling prices” or “floor prices” for particular goods or services. Ceiling price controls set a maximum price that may be charged but do not prohibit transactions at lower prices below the ceiling price (for example, rent control). Floor price controls set a minimum price that may legally be charged but do not prohibit transactions at higher prices above the floor price (for example, minimum wage laws).

Savings

All income of households (and firms) that is neither immediately spent on goods and services for final consumption nor taken by the government as taxes. Such savings may be held as balances in bank accounts or as cash on hand. Savings may be held for the purpose of subsequent investment or for some other purpose, such as accumulating sufficient funds for future consumption spending on big ticket items, maintaining an emergency reserve against the possibility of unpredicted consumption expenses, providing for post-retirement consumption spending, or even for the perverse psychological pleasures of hoarding in the miserly tradition of Silas Marner.

Laissez-faire

Literally, French for "Let do." The classical liberal (and modern libertarian) doctrine that the economic affairs of society are best guided by the free and autonomous decisions of individuals in the marketplace, to the near exclusion of government interference in economic matters. That is, the doctrine that government should almost always leave people alone and let them do as they please, so long as they respect the personal and property rights of others.

Subsidy

In general, a special money payment by a government to one or more firms in a favored industry, usually for the purpose of enabling them to sell one or more of their products at a price below their costs of production (or at least at a price below the free market price). Subsidies are typically advocated either to promote more widespread consumption of some good or service deemed to be especially essential or meritorious by the government ("merit goods"), to boost the levels of production of goods whose manufacture or consumption involves sizable "positive externalities" or partake of the nature of "public goods," or sometimes simply to stave off bankruptcy and unemployment in a declining industry or segment of an industry whose owners and/or workers enjoy a lot of political influence.

Scarcity

A condition where there is less of something available than at least some people would like to have if they could have them at no cost to themselves. Note that this technical economic definition of “scarcity” differs greatly from the notion of scarcity as “unusual rarity” that predominates in most ordinary language. (For example, automobiles are not currently “scarce” in Los Angeles in the sense of being rare or unusual to see, but they are definitely “scarce” in the economic sense because many Angelenos would certainly take more of them if they were being given away for free.) Because the total quantity of goods and services that people would like to have always far exceeds the amount which available economic resources are capable of producing in all known human societies, people as individuals and/or as members of larger social units must constantly be making choices about which desires to satisfy first and which to leave less than fully satisfied for the time being. That is, they must constantly decide how best to allocate (apportion or distribute) the scarce resources available to them among the various alternative uses to which they can be put. Thus scarcity is the fundamental condition that gives rise to the patterns of choosing behavior whose study constitutes the main focus of the academic discipline of economics.

Public sector

The part of an economy in which goods and services are produced and/or (re)distributed by government agencies.

Private sector

The part of an economy in which goods and services are produced and distributed by individuals and organizations that are not part of the government or state bureaucracy.

Supply, law of

Other things being held constant, the higher the price of a good (or service), the larger the quantity of that good (or service) that will be offered for sale in a particular time period.

Tariff

A tax imposed on goods imported from outside the country that is not imposed on similar goods from within the country. Import tariffs may be levied on an ad valorem basis, i.e., as a certain percentage of the estimated market value of the imported item; or on a "specific" basis, i.e., as a fixed dollar amount per unit imported. Import tariffs (or "duties") may be imposed mainly for the purpose of raising revenues because they are relatively cheap and easy taxes for a small or poorly organized government to collect, but more usually in developed industrial societies they represent a tiny fraction of revenues and are imposed primarily for other reasons of economic policy. "Protective" tariffs allow domestic producers of the good in question an artificial competitive advantage over their foreign competitors (largely at the expense of domestic consumers of these products) by making it impossible for the foreign producer to sell his goods as cheaply as he otherwise would -- thus allowing favored domestic producers to enjoy higher prices, a bigger market share, and bigger profits.

Unemployment

A situation which exists when members of the labor force wish to work at the prevailing wage or salary rates for their skills, but cannot get a job. The concept thus refers to "involuntary" unemployment only, rather than the voluntary decision of someone to choose leisure (or productive activity outside the cash economy such as housewifery) rather than gainful employment at prevailing rates of pay. Most post-World War II governments have made it a major goal of their economic policies to keep total unemployment in their national economies at relatively low levels (subject to certain practical constraints and trade-offs imposed by their pursuit of other important goals such as economic growth, low inflation, competitiveness in international trade, and so on).

Unemployment rate

A measure of the extent of unemployment in the labor force at some particular time, expressed as a percentage of the total available labor force. Nearly all national governments now have some statistical agency or department charged with gathering the necessary data and estimating the unemployment rate at frequent intervals (monthly or quarterly) for the guidance of policy-makers. In broad terms the underlying concepts are pretty similar from one country to the next: the number of people classified as unemployed is to be divided by the

number of people classified as being in the available labor force, with the result expressed in percentage terms. However, differences from country to country in classification rules and practical data collection methods used for estimating both the numerator and the denominator of this fraction make precise international comparison of unemployment rates very difficult, if not impossible. The use of jobless totals derived from the agencies that distribute unemployment insurance benefits is particularly suspect but nevertheless widely practiced by some countries' official statistical agencies. For example, some people may falsely claim they would accept a job offer at current wage rates when in fact they are making no effort (or only a token show of effort) to locate such a job, misreporting their intentions so that they may continue to draw unemployment benefits for a time. Other people may be actively, even desperately, seeking a job and yet not show up in such a count because they are technically ineligible for unemployment benefits (perhaps through lack of previous work experience or through having exhausted the time-limit) and so do not bother to report the success or failure of their job-hunting efforts to the government unemployment office. (Well-designed sample surveys of the population or of employers have much better validity for measuring the true unemployment rate but still have credibility problems of their own. For example, hundreds of thousands or even millions of people who are really gainfully employed but whose work is in illegal activities -- such as bootlegging, prostitution, drug-dealing, loan-sharking, illegal gambling operations, smuggling, or simply working conventional trades "off the books" to avoid taxes -- cheerfully deny having a job when questioned by government pollsters in suits who might well inform on them to the police.)

Entitlement program

The kind of government program that provides individuals with personal financial benefits (or sometimes special government-provided goods or services) to which an indefinite (but usually rather large) number of potential beneficiaries have a legal right (enforceable in court, if necessary) whenever they meet eligibility conditions that are specified by the standing law that authorizes the program. The beneficiaries of entitlement programs are normally individual citizens or residents, but sometimes organizations such as business corporations, local governments, or even political parties may have similar special "entitlements" under certain programs. 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.

The existence of entitlement programs is mainly significant from a political economy standpoint because of the very difficult problems they create for Congress's efforts to control the exact size of the budget deficit or surplus through the annual appropriations process. It is often very hard to predict in advance just how many individuals will meet the various entitlement criteria during any given year, so it is therefore difficult to predict what the total costs to the government will be at the time the appropriation bills for the coming fiscal year are being drafted. This makes it even harder for government to smooth out the business cycle or pursue other macroeconomic objectives through an active fiscal policy -- because these objectives require careful pre-planning of the size of the budget deficit or surplus to be run. In the first place, the amount of money that will be required in the coming year to fund an entitlement program is often extremely difficult to predict in advance because the number of people with an entitlement may depend upon the overall condition of the economy at the time. For example, the total amount of unemployment benefits to be paid out will depend upon the changing level of unemployment in the economy as the year wears on. Some very large entitlement programs (including Social Security pensions and government employee retirement programs) have been "indexed" to inflation, so that the size of the benefit is periodically adjusted according to a fixed formula based on unpredictable changes in the Consumers' Price Index. Perhaps more significantly, the amount of spending on entitlement programs is impossible for the Senate and House Appropriations committees to even attempt to adjust or to control because those committees do not have the jurisdiction to rewrite the laws that specify who gets how much and under what conditions. The various specialized standing committees who do have the jurisdiction to rewrite authorizing legislation each tend to be dominated by members whose political interests lie in expanding their particular entitlement program, not in cutting it back, and the political influence of the organized special interest groups that support the programs tends to be overwhelming on the specialized committees when such proposals arise.

Since the middle 1980s, entitlement programs have accounted for more than half of all federal spending. Taken together with such other almost uncontrollable (in the short run, that is) expenses as interest payments on the national debt and the payment obligations arising from long-term contracts already entered into by the government in past years, entitlement programs leave Congress with no more than about 25% of the annual budget to be scrutinized for possible cutbacks through the regular appropriations process. This very substantially reduces the practicality of trying to counteract the ups and downs of the overall economy through a "discretionary" fiscal policy because so very little of the budget is available for meaningful alteration by the Appropriations and Budget committees on short notice.

Key taxpayer provisions: ← Tax credit for workers: for 2009 and 2010 there is a "making work pay" tax credit of up to $400 for

working individuals and up to $800 for couples ← Temporary suspension of taxation on unemployment benefits: the jobless get a little more help with

a $25 increase in weekly benefit checks through 2009 and suspension of federal tax on the first $2,400 of unemployment benefits received in 2009

← Retirees and disabled individuals: those receiving Social Security benefits and individuals on disability will receive a one-time payment of $250 in 2009

← First-time home buyer credit: increased to $8,000 for qualified first-time homebuyers purchasing homes after Dec. 31, 2008 and before Dec. 1, 2009; repayment requirement waived unless sold or no longer

principal residence within 36 months ← "American Opportunity Tax Credit" for education: an 'enhanced' Hope credit applies to the first four

years of college; it provides 100% credit for the first $2,000 and 25% for the next $2,000 on qualified expenses such as tuition and books; the credit is 40% refundable, meaning even taxpayers who have no tax

liability can receive a credit for 40% of qualified college expenses, up to $1,000 ← 529 plans: qualified computer technology and equipment is now allowed as higher education

expenses from the plan, so distributions from 529 plans to buy a computer, for example, for college will not be taxable

← Earned Income Tax Credit: increased EITC amounts for families with 3 or more children and additional marriage penalty relief

← Additional Child Tax Credit: earnings threshold is lowered to $3,000, helping more people qualify for the credit and receive more money; for 2008 the earnings threshold was $8,500

← Vehicle purchase: state and local sales taxes paid for purchases of qualified new motor vehicles are deductible

← AMT: the one year typical patch for 2009 of the Alternative Minimum Tax (AMT) to prevent as many as 24 million middle-income households from being hit with a tax that was originally designed to prevent the

very wealthy from avoiding taxes

Where is Your Money Going?

FREQUENTLY ASKED QUESTIONS

What is Recovery.gov? Where can I learn more about how the American Recovery and Reinvestment Act will

affect the budget? How will the Recovery Act work? I heard I'd be able to track recovery funds. Why can’t I do that? Who runs Recovery.gov? I want to help. What can I do? How can I see how much recovery money is coming to my community? What is the purpose of the new legislation? Where can I find the full text of The American Recovery and Reinvestment Act of 2009? What type of programs will this recovery package fund? What will I be able to locate on Recovery.gov? What is a better way to find the information I’m looking for - browsing or searching? How does Recovery.gov differ from USASpending.gov? How can I contact the Administration with questions or comments about Recovery.gov

and the recovery package? Is Recovery.gov accessible for people for with disabilities? What is a fiscal year (FY)? Is the spending data on recovery.gov available in a format (like XML) that developers

can use to create mashups and gadgets?

Q: What is Recovery.govA: Recovery.gov is a website that lets you, the taxpayer, figure out where the money from the American Recovery and Reinvestment Act is going. There are going to be a few different ways to search for information. Within days after the signing of the legislation, Federal agencies will start distributing funds, and you will be able to see which states, Congressional districts, and even Federal contractors are receiving them. As soon as we are able to, we'll display that information visually, through maps, charts, and graphics.

Q: Where can I learn more about how the American Recovery and Reinvestment Act will affect the budget?A: The Congressional Budget Office (CBO) has calculated the impact that the American Recovery and Reinvestment Act will have on the federal government's budget deficit. You can review those calculations in full, or read a summary on the CBO blog. For more information visit the White House website or, for legislative information, the Library of Congress's THOMAS.

Q: How will the Recovery Act work? A: Very soon, the different agencies -- such as the Departments of Education; Health and Human Services; and Energy -- will decide who will receive award grants and contracts. Sometimes the money will go to a state government; other times, the funds will go directly to a school, hospital, contractor, or other organization. Agencies will then deliver that information to the Recovery.gov team. We will subsequently make the information available on Recovery.gov, and you will be able to track where the money is going. You'll be able to search by state or even by Congressional district; you'll be able to look up names of Federal

contractors or other recipients of Federal dollars; and you'll be able to send in comments, thoughts, ideas, questions, and any responses you have to what you find.

Q: I heard I'd be able to track recovery funds. Why can't I do that?A: You aren't able to track funds yet because we have not yet started receiving information from Federal agencies on how they are going to allocate the money. It takes a little bit of time for them to make sure your money is going to be spent wisely. Right now, the site features an overview of the law and an explanation of what it is intended to accomplish. You will have access to data as soon as we begin receiving it from agencies.

Q: Who runs Recovery.gov?A: The American Recovery and Reinvestment Act establishes an oversight board of inspectors general (the watchdogs of government) called the Recovery Accountability and Transparency Board, which is responsible for overseeing Federal agencies to ensure that there is transparency and accountability for the expenditure of recovery funds. For the interim period until that board becomes operational, the President has coordinated a team from across Federal agencies to track Recovery Act dollars and report findings on this website.

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Q: I want to help. What can I do?A: Over the course of the spring, increasing amounts of information will become available on Recovery.gov that will show where the money is going. We are counting on you to peruse that information and tell us what you find. Please share your stories, your ideas, and your comments. They will then be sent to the Board for their review.

Q: How can I see how much recovery money is coming to my community?A: Until the funding is distributed by the Federal government to states and local governments, and eventually to your community, we won't be able to determine exactly where all of the funding will go. Over the next few weeks and months, there's going to be a lot of data coming in, as we coordinate with different agencies. As soon as the first dollars start to go out, you'll be able to track where the money is going. Detailed state maps will be available to assist your tracking.

Q: What's the purpose of the new legislation?A: The purpose of the Recovery Act is to create and save jobs, jumpstart our economy, and build the foundation for long-term economic growth. The Act includes measures to modernize the nation's infrastructure, enhance America's energy independence, expand educational opportunities, increase access to health care, provide tax relief, and protect those in greatest need.

Q: Where can I find the full text of The American Recovery and Reinvestment Act of 2009?A: The text of the law can be found in Text or PDF format here.

Q: What type of programs will this recovery package fund?A: The Recovery Act specifies appropriations for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs. The legislation also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws. The package provides funds that will:

Create a framework for clean, efficient, American energy; Transform our economy with science and technology; Modernize roads, bridges, transit and waterways; Overhaul education for the 21st Century; Dispense tax cuts to make work pay and create jobs; Expand access to healthcare and lower costs; Provide assistance to workers hurt by the economy; Save public sector jobs and protect vital services;

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Q: What will I be able to locate on Recovery.gov?A: Federal agencies are taking in bids for recovery projects, so right now, Recovery.gov features a summary of the funds that are allocated for different programs, as well as the responsible Federal agencies. As Federal agencies and other recipient organizations report information about their spending plans, we will post that information on the site. We are currently developing systems to track the funds and report results.

Q: What’s a better way to find the information I’m looking for -- browsing or searching?A: The website will have both functions, but for now, browsing is a better bet. As we begin to fill the database with more data, the search function will be more useful in finding specific information.

Q: How does Recovery.gov differ from USASpending.gov?A: Recovery.gov tracks only the targeted investments allocated by the American Recovery and Reinvestment Act. USASpending.gov collects data about all types of contracts, grants, loans, and spending across government agencies.

Q: How can I contact the Administration with questions or comments about Recovery.gov and the recovery package?A: The best method to comment or ask a question on Recovery.gov is to use our contact us form. The question or message will be referred to the best person to handle the matter, and they will respond as quickly as possible.

For questions about the federal government, visit USA.gov or call 1 (800) FED INFO (1-800-333-4636) (8 am-8 pm ET Monday-Friday).

Q: Is Recovery.gov accessible for people for with disabilities?A: Recovery.gov complies with all of the automatic checkpoints of the Section 508 Accessibility Guidelines, and has been manually verified for nearly all of the manual checkpoints.

This compliance has been tested using Watchfire WebXACT program. Because Recovery.gov uses dynamically generated Web pages, it is not possible to test literally every page. However, each dynamically generated output style can be tested. We plan to continue to upgrade Recovery.gov's accessibility for individuals with disabilities in forthcoming updates.

Q: What is a fiscal year (FY)?A: For accounting purposes, the Federal government uses a defined 12-month period as a financial or fiscal year. The Federal fiscal year begins on October 1 and ends on September 30 of the following calendar year. For instance, fiscal year 2009 is 10/1/2008 - 9/30/2009.

Q: Is the spending data on recovery.gov available in a format (like XML) that developers can use to create mashups and gadgets?A: Not at this time. But, as new systems are developed to capture the allocations and expenditures under the Act, we plan to make that data available in exportable form.

Economic and Regulatory Policy

What IF… The Federal Government were required to Balance its Budget?Good Times, Bad TimesFiscal PolicyMonetary PolicyWorld TradeThe Politics of TaxesThe Social Security Problem

1. Graphic Organizer 2. Which Side are you on: Social Security Privatization

3. Remedy/Solutions/Possiblities/Alternativesthis chapter, they should be able to: Correctly define a series of basic terms used in discussions of economic policy, including

inflation, unemployment, the business cycle, recession, depression, and budget deficit. Explain the essential tools of fiscal policy, namely increasing the budget deficit during a

recession and reducing it during a boom. Describe how the Federal Reserve System implements monetary policy (increasing or

decreasing the rate of growth of the money supply).

Explain why fiscal policy may be more effective against recessions, and monetary policy against inflation.

Identify some of the important events in the history of economic policy since World War II, including Kennedy’s use of Keynesianism, the triggering of inflation under Johnson, Volker’s suppression of inflation, Bill Clinton’s tax increase, and George W. Bush’s return to budget deficits.

Define key concepts used in the discussion of world trade, including imports, exports, quotas, and tariffs.

Understand some of the arguments economists advance in favor of free trade. Describe the role of the WTO. Define the current account balance and understand what happens when the balance is

negative. Understand the concept of a marginal tax rate. Define progressive and regressive taxes and identify which taxes fall into each category. Understand the pay-as-you-go character of Social Security. Describe some of the proposals that have been advanced to guarantee the survival of the

Social Security system in the future.

TOPICS FOR DISCUSSIONSome advocate the idea of the government as the “employer of last resort,” a means of obtaining

a job when no other jobs are available. What positive results might result from this system? What impact might such a system have on the poor? Would it be beneficial to their self-esteem, or injure it?

Who benefits from inflation? Who would be hurt most by it? (Some answers are provided in “Beyond the Book.”)

How could the nation address the problem of politicians adopting only the easier half of Keynesian fiscal policy, that is, their willingness to reduce taxes during recessions but reluctance to raise taxes during a boom?

Britain has recently made the Bank of England—which performs functions that in America are performed by the Fed—politically independent of the nation’s elected leaders. In other words, Britain has given the Bank the independence the Fed already has. Why do you think the British may have done this?

What problems might follow from twelve European nations all adopting the same currency, the Euro? (Hint: they will then all have the same monetary policy.)

Why are the public and the economics profession on such different wavelengths when it comes to world trade?

How much of a problem is it that the United States has become so dependent on money borrowed from foreign countries (the increasing current account deficit)? What might happen if foreigners stopped lending? (Hint: we’d have to start paying the money back.)

Is progressive taxation “fair”? What arguments could be made that it is fair or unfair?

Which of the proposals advanced to “fix” Social Security have the most merit? Which would cause the most problems?

BEYOND THE BOOKMost people think that inflation is bad. After all, inflation means higher prices, and when we have

to pay higher prices, are we not necessarily worse off? The obvious answer, yes, is not quite the correct one, though. The truth is that inflation affects different people differently. Its effects also depend on whether it is anticipated or unanticipated. In most situations, unanticipated inflation benefits borrowers because the interest rate they are being charged does not fully compensate for the inflation that actually occurred. In other words, the lender did not anticipate inflation correctly. Whenever inflation rates are underestimated for the life of a loan, creditors lose and debtors gain. For example, periods of considerable unanticipated (higher-than-anticipated) inflation occurred in the late 1960s and the early and late 1970s. During those years, creditors lost and debtors gained.

Banks attempt to protect themselves against inflation by raising interest rates to reflect anticipated inflation. Adjustable-rate mortgages in fact do just that: the interest rate varies according to what happens to interest rates in the economy. Workers can protect themselves through cost-of-living adjustments (COLAs), which are automatic increases in wage rates to take account of increases in the price level. To the extent that you hold cash, you will lose because of inflation. If you have put $100 in a mattress and the inflation rate is 10 percent for the year, you will have lost 10 percent of the purchasing power of that $100. If you have your funds in a non-interest-bearing checking account, you will suffer the same fate. Individuals attempt to reduce the cost of holding cash by putting it into interest-bearing accounts, many of which pay rates of interest that reflect anticipated inflation.

Some economists believe that the main cost of inflation is the cost of resources used to protect against inflation and the distortions introduced as firms attempt to plan for the long run. Individuals have to spend time and resources to figure out ways to cover themselves if inflation is different from what it has been in the past. That may mean spending a longer time working out more complicated contracts for employment, for purchases of goods in the future, and for purchases of raw materials. Another major problem with inflation is that it usually does not proceed perfectly evenly. Consequently, the rate of inflation is not exactly what people anticipate. When this is so, the purchasing power of money changes in unanticipated ways. Because money is what we use as the measuring rod of the value of transactions we undertake, we have a more difficult time figuring out what we have really paid for things during periods of inflation that proceed unevenly. As a result, in such situations, resources, such as labor and capital, tend to be misallocated because people have not really valued them accurately.

Inflation has been common during or immediately after a war. In 1980, however, the United States experienced rates of inflation exceeding 12 percent in a time of peace. What caused

this inflation? Several factors were important. Policy errors by presidents Lyndon Johnson (1963–1969) and Richard Nixon (1869–1974) allowed inflation to take an initial hold. Then came the great oil price shock of the 1970s. By that decade, the United States had lost its self-sufficiency in producing oil and was reliant on oil imports. The oil-producing nations of the Middle East, joined together in the Organization of Petroleum Exporting Countries (OPEC), realized that for the first time they could control the amount and price of oil in world trade. In 1973, the United States supported Israel in a war with its neighbors. Arab oil producers attempted to punish the United States for this support by launching an oil embargo against it. (An embargo is a refusal to engage in international trade.) The Arabs lifted the embargo the following year, but kept prices high. Additional policy mistakes by President Jimmy Carter (1977–1981) let high oil prices drive up the price of almost everything else. By the last years of Carter’s administration, the United States was experiencing high inflation and high unemployment at the same time. Not surprisingly, Carter lost the presidential election of 1980 to Republican candidate Ronald Reagan.

The success of Volker’s policies in fighting inflation gave new impetus to a school of economic thinking known as monetarism. Advocates of this philosophy oppose the use of fiscal policy and believe that the government’s role in managing the economy should be limited to monetary policy. Some monetarists believe that the government cannot act quickly enough to fine-tune the economy using fiscal policy. Others argue that ultimately, fiscal policy does not determine the course of the economy at all. The size of the money supply is the only important long-run variable. Milton Friedman, perhaps the most famous monetarist, advocated a non-discretionary monetary policy. Under this theory, policymakers should increase the money supply smoothly at a rate consistent with the economy’s long-run potential growth rate. Such a policy has not been adopted in the United States, however. Fed chairman Greenspan has regularly employed discretionary monetary policy to heat or cool the economy, with some success.

A nation’s particular distribution of resources often gives it an absolute advantage over another nation in the production of one or more goods. Obviously, Colombia’s tropical climate and relatively inexpensive labor make it ideally suited for growing coffee. Even using the same amount of resources, a country with a moderate climate, such as Belgium, would produce quite a bit less coffee than Colombia. We say that Colombia has an absolute advantage in coffee production over Belgium. Often, the world can gain additional output from trade even when a nation does not have an absolute advantage in producing the goods or services that it exports. For example, a country may be able to produce one type of good—such as soybeans—much more efficiently than it can produce other goods—such as cotton. In this circumstance, the country has a comparative advantage in producing soybeans. The world as a whole may benefit if this country produces soybeans for export even if certain other

countries can produce soybeans more cheaply. The benefit stems from the greater efficiency enjoyed by the exporting country. By specializing in soybeans—instead of wasting its resources by producing cotton inefficiently—the exporting nation increases its own overall productivity. Through international trade, the world as a whole can then benefit from the efficiency gain.

International trade also bestows benefits on countries through the transmission of ideas. International trade has been the principal means by which new goods, services, and processes have spread around the world. In recent years, some activists have objected to this process, seeing it as part of a “globalization” that destroys world diversity. People around the world, however, rarely adopt foreign ideas unless they benefit from them in some way. For a historical example, coffee was initially grown in Arabia near the Red Sea. Around 675 B.C., coffee began to be roasted and consumed as a beverage. Eventually, it was exported to other parts of the world; the Dutch started cultivating it in their colonies in the 1600s and the French in the 1700s. Consider also the lowly potato, which is native to the Peruvian Andes. In the 1500s, it was carried to Europe by Spanish explorers. Thereafter, its cultivation and consumption spread rapidly.

Today, we talk about international trade’s role in spreading intellectual property—ideas, patents, inventions, software, movies, music, and the like. Virtually all of the intellectual property used throughout the world today has been transmitted through international trade. Finally, production processes are transmitted through international trade. For example, an important Japanese manufacturing innovation, known as just-in-time inventory control, is now common in U.S. factories. Rather than having large stocks of parts for manufacturing cars and computers, firms that make these products (and others) have the necessary parts arrive just when they are needed. This reduces the cost of holding inventories. Just-in-time systems reduce manufacturing costs as a consequence.

Textile import quotas can serve as an example of quotas. The result of the quotas is that U.S. consumers pay a higher price on imported textiles. In addition, they pay a higher price on substitute domestic textiles. This benefits domestic textile producers. The U.S. textile industry has its own import restricting organization called the Committee for Implementation of Textile Agreements (CITA). The CITA holds no open meetings. At times, it has placed quotas on men’s underwear from the Dominican Republic, cotton nightwear from Jamaica, and wool coats from Honduras. The benefit from CITA quotas for the U.S. textile industry has been estimated as high as $12 billion in additional profits each year.

CHAPTER OUTLINE

A major economic policy issue is how to maintain stable economic growth without falling into either excessive unemployment or inflation (rising prices). Key concept: Inflation, a sustained rise in the general price level of goods and services.I. Good Times, Bad Times

The U.S. economy experiences booms and busts. The busts are called recessions. Key concept: Recession, two or more successive quarters in which the economy shrinks instead of grows.A. Unemployment. Political leaders have a powerful incentive to keep the rate of

unemployment down. Key concept: Full employment, an arbitrary level of unemployment that corresponds to “normal” friction in the labor market. In 1986, a 6.5 percent rate of unemployment was considered full employment. Today, it is assumed to be around 5 percent.1. Unemployment Becomes an Issue. The federal government did not concern itself

with unemployment until the Great Depression of the 1930s. At the beginning of the depression, unemployment passed 25 percent, the highest rate in U.S. history. Since the 1930s, the federal government offers unemployment insurance as a benefit. Not all members of the labor force are eligible for the insurance, however.

2. Measuring Unemployment. The Department of Labor and the Bureau of the Census have competing methods of calculating unemployment. Standard figures, however, do not include “discouraged workers” who have given up on looking for a job.

B. Inflation. Inflation can be measured by changes in the Consumer Price Index (CPI). Key concept: the Consumer Price Index, a measure of the change in price over time of a specific group of goods and services used by the average household. Over time, inflation adds up. Today’s dollar is worth about as much as a 1900 nickel.

C. The Business Cycle. Economists call the cycle of recurring booms and busts the business cycle. An extremely severe recession is called a depression.

II. Fiscal PolicyFiscal policy is concerned with achieving economic policy goals through changes in spending or levels of taxation. A. Keynesian Economics. Fiscal policy is typically based on the ideas of the British

economist John Maynard Keynes (1883–1946). Keynes believed that after falling into a recession or depression, a modern economy may become trapped in an ongoing state of less than full employment.1. Government Spending. Therefore, in a recession or depression, the government

should engage in spending to make up for the spending that is not happening in the private sector.

2. Government Borrowing. For this to work, the spending must be paid for by borrowing, not new taxes. In other words, the government must run a budget

deficit. The borrowing undertaken by the government makes up for the borrowing that is not happening in the private sector.

3. Discretionary Fiscal Policy. This is the discretionary—voluntary—use of fiscal policy to fine-tune the economy. John F. Kennedy was the first president to explicitly accept Keynesian economics, and he proposed a tax cut in line with the theory. The tax cut proved to be a successful economic stimulus.

4. Discretionary Fiscal Policy Failures. Keynesian theory calls for reducing or eliminating the budget deficit during boom times, the opposite of what is done during a recession. Lyndon Johnson, Kennedy’s successor, refused to ask Congress for tax increases to pay for the Vietnam War, at a time when the economy was booming. The result of Johnson’s running an increased budget deficit during boom times was to initiate a decade-and-a-half long period of substantial inflation.

B. The Thorny Problem of Timing. With fiscal policy, timing is a problem. By the time an antirecessionary increase to the budget deficit has made it through Congress, the country might be back in a boom.

C. Automatic Stabilizers. Some government programs work to counteract the business cycle automatically. For example, even with no changes to the law, relatively less income tax is collected in a recession (putting up the deficit) and relatively more is collected in a boom (reducing the deficit). Unemployment compensation has the same effect.

D. Deficit Spending and the Public Debt.The government funds its deficit primarily by selling U.S. treasury bonds. Twenty years ago, only 15 percent of these bonds were held abroad. Today the figure is nearly 50 percent.1. The Public Debt in Perspective. Key concept: Net public debt, the accumulation of

all past federal government deficits; the total amount owed by the federal government to individuals, businesses, and foreigners. (It does not include what the government owes to itself.) We measure the seriousness of the net public debt by measuring it against the gross domestic product (GDP), the dollar value of all final goods and services produced in a one-year period.

2. Are We Always in Debt? From 1960 until the last few years of the twentieth century, the federal government spent more than it received in all but two years. Politicians have been happy to implement Keynesianism during recessions, but shy away from it during booms. In 1993, however, President Bill Clinton deliberately obtained a tax increase as the nation was entering a boom. The apparent results of the policy were quite beneficial. From 1998 to 2002, the government actually ran a budget surplus. Since the dot-com bust and the 2001-2002 recession, however, George W. Bush has followed a policy of high spending and tax cuts that have increased the budget deficit greatly.

III. Monetary Policy

Key concept: Monetary policy, the utilization of changes in the amount of money in circulation to alter credit markets, employment, and the rate of inflation.A. Organization of the Federal Reserve System. The Federal Reserve System, or Fed, sets

monetary policy, not the president or Congress. The key body for carrying out the policy is the Federal Open Market Committee.

B. Loose and Tight Monetary Policies. The Fed implements policy by increasing or reducing the rate of growth of the money supply. Increasing the rate of growth is loose monetary policy. Reducing the rate is tight monetary policy.

C. Time Lags for Monetary Policy. Like fiscal policy, monetary policy has a problem with time lags, but the Fed can make a policy change more quickly than Congress.

D. The Way Federal Reserve Policy is Announced. The Fed announces changes to monetary policy by raising or lowering the federal funds rate, a government-controlled interest rate for funds that banks borrow from each other. This interest rate actually has little effect on the economy. The true effect of the Fed’s policy comes from controlling the size of the money supply.

E. Monetary Policy versus Fiscal Policy. If interest rates go high enough, people will stop borrowing and inflation will subside. Monetary policy, however, cannot force people to borrow money in a recession. Therefore, while monetary policy is more powerful against inflation, fiscal policy is more effective against recessions, because the government does the borrowing itself.

IV. World TradeWhile a majority of the public is skeptical of the benefits of world trade, almost all economists of all political persuasions support it.A. Imports and Exports. Key concepts: Imports, goods and services produced outside a

country but sold within its borders. Exports, goods and services produced domestically for sale abroad. Imports make up about 15 percent of our consumption, and exports make up about 13 percent of our production. While world output has increased by about eight times since 1950, world trade has increased by more than twenty-one times.

B. The Impact of Import Restrictions on Exports. “In the long run, imports are paid for by exports.” If we restrict the ability of the rest of the world to sell goods and services to us, then the rest of the world will not be able to purchase all of the goods and services that we want to sell to them.1. Protecting American Jobs. If imports are restricted to save American jobs, the

price of the good or service in question goes up, hurting consumers. Further, there will be job losses in export industries.

2. Quotas and Tariffs. Imports are restricted by tariffs, or taxes on imports, or by import quotas that restrict the value or number of items of a particular good or service that can be imported. A severe new tariff in 1930 worsened the impact of the Great Depression.

3. Free Trade Areas and Common Markets. Groups of nations have created alliances to lower trade restrictions. The most important of these, once called the Common Market, has evolved into the European Union, a confederation of states. In North America, the North American Free Trade Association (NAFTA) reduces trade barriers between the United States, Mexico, and Canada.

C. The World Trade Organization. The WTO seeks to lower trade barriers worldwide. 1. What the WTO Does. The WTO also has a dispute-resolution mechanism that

nations may use.2. The WTO and Globalization. The WTO has become the focus of those who fear

the supposed dangers of globalization. It is true that neither the United States nor any other country has a veto power within the WTO.

D. The Balance of Trade and the Current Account Balance.Key concept: The balance of trade, or the difference between the value of a nation’s exports of goods and its imports of goods. The U.S. balance of trade has been significantly negative for many years.1. The Current Account Balance. This is a broader concept than the balance of trade.

The current account balance includes the balance of trade in services, unilateral transfers, and other items. It is also negative and has been growing more so.

2. Are We Borrowing Too Much from Other Countries? Because imports and exports must balance, the current account deficit means that we have been exporting dollars, or future claims on our production. Another way of looking at this is to say that foreigners are lending us money. Is America using this money wisely? If productively invested, the borrowed money can pay for itself. If it is merely used for consumption, however, we have a problem.

V. The Politics of TaxesCurrently, Americans pay taxes that total to somewhat less than 30 percent of the GDP.

A. Federal Income Tax Rates. Not all of your income is taxed at the same rate. The first few dollars you make are not taxed at all. The highest rate is imposed on the “last” dollar you make. This highest rate is the marginal tax rate. High marginal tax rates inspire major efforts to avoid the taxes.

B. Loopholes and Lowered Taxes. Special interests may lobby Congress for “loopholes’ that will allow them to shelter income from taxation. Loopholes make the tax system dauntingly complex.1. Progressive and Regressive Taxation. Key concepts: Progressive tax, a tax that

rises in percentage terms as incomes rise. Regressive tax, a tax that falls in percentage terms as incomes rise.

2. Who Pays? Liberals tend to favor progressive taxes. Conservatives either favor taxes that are less progressive, or even flat or regressive. The following taxes are progressive: federal and (most) state income taxes, the federal corporate income tax, and the estate tax. The following taxes are regressive: the Social Security tax,

the Medicare tax, state sales taxes, and the local property tax. Taken as a whole the tax system is probably slightly progressive.

VI. The Social Security ProblemSocial Security was established in 1935 with the intent of providing a type of insurance for a large segment of the public. Employees and their employers pay a tax on a percentage of the employees’ wages. A. Social Security is Not a Pension Fund.

However, unlike private insurance programs where the individual insured makes payments in to an account for his or her own policy, the money paid into the Social Security program is used to provide benefits for people who have already retired, or who are qualified to receive funds.

B. Workers per Retiree. Initially for every recipient of Social Security there were forty workers paying into the general fund—a one-to-forty ratio. Today, the ratio is more like one-to-three, and it will get worse in future years. The ballooning cost of Medicare, however, may strain the system even more than the cost of Social Security.

C. What Will It Take to Salvage Social Security?1. Raise Taxes. One proposal for fixing Social Security is to raise taxes. This could

be accomplished by increasing the percentage of taxes withheld, or by eliminating the current cap on wages on which the payroll tax is withheld. Such proposals, however, would not provide a complete fix.

2. Other Options. Another proposal is to reduce benefit payouts. This could be done by increasing the age of full eligibility to 70 or by imposing a means test for benefits. Another proposal is to reform immigration policies so that more immigrants are admitted to pay the tax.

VII. Features. A. What If . . . The Federal Government Was Required to Balance Its Budget?

Such a change would be likely to increase the tax rates of middle-class Americans, since this is the primary tax-paying group in the United States. It might also result in higher taxes paid by corporations, but this would simply be passed on to consumers with higher prices and workers with lower salaries. While spending cuts are another means of achieving this objective, it would probably involve the elimination of programs and services that would cause many Americans considerable pain. One of the great misconceptions of modern politics is that by eliminating pork barrel spending we could take great strides toward achieving a balanced budget. The reality is that such spending, while gaining much media attention, actually comprises a small part of our budget.

B. Politics and Trade—The High Cost of Saving U.S. Jobs.

Using the example of the “voluntary” import restrictions on automobiles, an economist calculated that the higher price of cars cost consumers $6.5 billion a year, or $250,000 per year for each job saved.

C. Beyond Our Borders: Sending Work Overseas. Outsourcing is essentially importing services. Service jobs, such as phone centers, can be said to be “outsourced” abroad. However, the percentage of jobs being outsourced is relatively small. In addition, the United States has a positive balance of trade in services, in contrast to the state of our balance of trade in goods. More jobs are “outsourced” to us than from us.

D. Which Side Are You On? Should Social Security Be Partially Privatized?One proposal to reform Social Security, in the hopes of increasing the implicit rate of return on contributions, is a partial privatization plan, whereby workers could opt to take 2 percent of their Social Security payroll tax and invest to build their own retirement. This would mean that people could have some control over their retirement nest egg, but would not completely jeopardize their retirement income. There are numerous critics of this plan. The biggest problem with it is that it diverts funds that would be paid to today’s retirees. Keeping our promise to the currently retired plus adding a privatized system could actually cost vast sums of money, forcing up taxes.

How the stimulus bill affects youThe $787 billion package might cut your taxes, make your health insurance cheaper, fix the roads you drive on and keep the best teachers in your children's schools. And that's just for starters.[Related content: Barack Obama, economy, education, energy, recession]By The Associated Press Here's an examination of how the economic stimulus plan will affect Americans.

Taxes The recovery package has tax breaks for families that send a child to college, purchase a new car, buy a first home or make the one they own more energy efficient. Millions of workers can expect to see about $13 extra in their weekly paychecks, starting around June, from a new $400 tax credit to be doled out through the rest of the year. Couples would get up to $800. In 2010, the credit would be about $7.70 a week, if it is spread over the entire year.A $1,000 child tax credit would be extended to more low-income families that don't make enough money to pay income taxes, and poor families with three or more children will get an expanded earned income tax credit.Middle-income and wealthy taxpayers will be spared from paying the alternative minimum tax, which was designed 40 years ago to make sure wealthy taxpayers paid at least some tax but was never indexed for inflation. Congress fixes it each year, usually in the fall.Talk back: How will you use your tax refund?First-time homebuyers who purchase their homes before Dec. 1 will be eligible for an $8,000 tax credit, and people who buy new cars before the end of the year can write off the sales taxes.Homeowners who add energy-efficient windows, furnaces and air conditioners can get a tax credit to cover 30% of the costs, up to a total of $1,500. College students -- or their parents -- are eligible for tax credits of up to $2,500 to help pay tuition and related expenses in 2009 and 2010.

Those receiving unemployment benefits this year won't owe federal income taxes on the first $2,400 they receive.

Health insurance Many workers who lose their health insurance when they lose their jobs will find it cheaper to keep that coverage while they look for work. Right now, most people who work for medium or large employers can continue their coverage for 18 months under the COBRA program (named for the Consolidated Omnibus Budget Reconciliation Act) when they lose their jobs. The coverage is expensive, often more than $1,000 a month, because the newly unemployed pay the share of premiums once covered by their employer as well as their own share from the old group plan.Under the stimulus package, the government will pick up 65% of the total cost of that premium for the first nine months. More from MSN Money

How consumerism hurts consumers Just getting by . . . on $32,000 a year Get a credit card reprieve Steer clear: 4 'hot opportunities' to avoid Too late to avoid a depression?Lawmakers initially proposed also helping workers from small companies who don't generally qualify for COBRA coverage. But that fell through. The idea was to have Washington pay to extend Medicaid to that group. COBRA applies to group plans at companies employing at least 20 people. The subsidies will be offered to those who lost their jobs from Sept. 1, 2008, to the end of 2009.Those who were put out of work after September but didn't elect to have COBRA coverage at the time will have 60 days to sign up.The plan also offers $87 billion to help states administer Medicaid. That could slow or reverse some of the steps states have taken to cut the program.

Infrastructure Highways repaved for the first time in decades. Century-old waterlines dug up and replaced with new pipes. Aging bridges, stressed under the weight of today's SUVs, reinforced with fresh steel and concrete. But the $90 billion is a mere down payment on what's needed to repair and improve the country's physical backbone. And not all economists agree it's an effective way to add jobs in the long term, or to stimulate the economy.

Energy Homeowners looking to save energy, makers of solar panels and wind turbines, and companies hoping to bring the electric grid into the computer age all stand to reap major benefits.

The package contains more than $42 billion in energy-related investments, from tax credits for homeowners to loan guarantees for renewable energy projects and direct government grants for makers of wind turbines and next-generation batteries. Video on MSN Money

Profit from the stimulus planHow can investors make money from the economic stimulus legislation? A CNBC panel of investment pros spots potential winners and losers. (Feb. 13) There's a 30% tax credit of up to $1,500 for the purchase of high-efficiency residential air conditioners, heat pumps and furnaces. The credit also can be used by homeowners to replace drafty windows or put more insulation into the attic. About $300 million would go for rebates to get people to buy more efficient appliances. The package includes $20 billion aimed at "green" jobs to make wind turbines and solar panels and to improve energy efficiency in schools and federal buildings. It includes $6 billion in loan guarantees for renewable energy projects, as well as tax breaks and direct grants covering 30% of wind and solar energy investments. An additional $5 billion is marked to help low-income homeowners make energy improvements.About $11 billion goes to modernizing and expanding the nation's electric power grid and $2 billion to spur research into batteries for future electric cars.

Schools A main goal of education spending in the stimulus bill is to help keep teachers on the job. Nearly 600,000 jobs in elementary and secondary schools could be eliminated by state budget cuts over the next three years, according to a study released last week by the University of Washington. Fewer teachers mean bigger classes, something that districts are scrambling to prevent.The stimulus sets up a $54 billion fund to help prevent or restore state budget cuts, of which $39 billion must go toward kindergarten through 12th grade and higher education. In addition, about $8 billion of the fund could be used for other priorities, including modernization and renovation of schools and colleges, though how much is unclear, because Congress decided not to specify a dollar figure.The Education Department will distribute the money as quickly as it can over the next couple of years.And it adds $25 billion extra to No Child Left Behind and special education programs, which help pay teacher salaries, among other things.This money may go out much more slowly; states have five years to spend the dollars, and they have a history of spending them slowly. In fact, states don't spend all the money; they return nearly $100 million to the federal treasury every year.The stimulus bill also includes more than $4 billion for Head Start early education programs and for child care programs.

National debt One thing about the president's $790 billion stimulus package is certain: It will jack up the federal debt. Whether or not it succeeds in producing jobs and taming the recession, tomorrow's taxpayers will end up footing the bill.Forecasters expect the 2009 deficit -- for the budget year that began Oct. 1, 2008 -- to hit $1.6 trillion, including new stimulus and bank-bailout spending. That's about three times last year's shortfall.The torrents of red ink are being fed by rising federal spending and falling tax revenues from hard-hit businesses and individuals.

The national debt -- the sum of money owed by all levels of government -- stands at $10.7 trillion, or about $36,000 for every man, woman and child in the U.S.Interest payments alone on the national debt will near $500 billion this year. It's already the fourth-largest federal expenditure, after Medicare-Medicaid, Social Security and defense.This will affect us all directly for years, as well as our children and possibly grandchildren, in higher taxes and probably reduced government services. It will also force continued government borrowing, increasingly from China, Japan, Britain, Saudi Arabia and other creditors.

Environment The package includes $9.2 billion for environmental projects at the Interior Department and the Environmental Protection Agency. The money would be used to shutter abandoned mines on public lands, help local governments protect drinking water supplies, and erect energy-efficient visitor centers at wildlife refuges and national parks.

The Interior Department estimates that its portion of the work would generate about 100,000 jobs in the next two years.

Yet the plan will make only a dent in the backlog of cleanup projects facing the EPA and in the long list of chores at the country's national parks, refuges and other public lands.

Talk back: How will you use your tax refund?

The plan sets aside $735 million for road repairs and maintenance at national parks. But that's just a fraction of the $9 billion worth of work waiting for funding.

At the EPA, the payout is $7.2 billion. The bulk of the money will help local communities and states repair and improve drinking water systems and fund projects that protect bays, rivers and other waterways used as sources of drinking water.

The rest of the EPA's cut -- $800 million -- will be used to clean up leaky gasoline storage tanks and the nation's hazardous waste sites.

Police The stimulus bill includes plenty of green for those wearing blue.

The compromise bill doles out more than $3.7 billion for police programs, much of which is set aside for hiring new officers.

The law allocates $2 billion for the Byrne Justice Assistance Grant, a program that has funded drug task forces and such things as prisoner-rehabilitation and after-school programs.

An additional $1 billion is set aside to hire local police under the Community Oriented Policing Services program.

More from MSN Money

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The program, known as COPS grants, paid the salaries of many local police officers and was a "modest contributor" to the decline in crime in the 1990s, according to a 2005 government oversight report.

Both programs had been eliminated during the Bush administration.

The bill also includes $225 million for general criminal justice grants for programs such as youth mentoring, $225 million for Indian tribe law enforcement, $125 million for police in rural areas, $100 million for victims of crimes, $50 million to fight Internet crimes against children and $40 million in grants for law enforcement along the Mexican border.

Higher education The maximum Pell Grant, which helps the lowest-income students attend college, will increase from its current limit of $4,731 to $5,350 starting July 1 and to $5,550 in 2010-11. That ill cover three-quarters of the average cost of a four-year college. An additional 800,000 students, for a total of about 7 million, should now qualify for Pell funding.

The stimulus also increases the tuition tax credit to $2,500 and makes it 40% refundable, so families that don't earn enough to pay income tax can still get up to $1,000 in extra tuition help.

In addition, computer expenses will now be an allowable expense for 529 college savings plans.

The final package cut $6 billion the House wanted to spend to kick-start building projects on college campuses. But parts of the $54 billion state stabilization fund -- with $39 billion set aside for education -- can be used for modernizing those facilities.

Video on MSN Money

Profit from the stimulus planHow can investors make money from the economic stimulus legislation? A CNBC panel of investment pros spots potential winners and losers. (Feb. 13) There's also an estimated $15 billion for scientific research, much of which will go to universities. Funding for the National Institutes of Health includes $1.5 billion set aside for university research facilities.

Altogether, the package spends an estimated $32 billion on higher education.

The poor More than 37 million Americans live in poverty, and the vast majority of the poor are in line for extra help under the giant stimulus package. Millions more could be kept from slipping into poverty by the economic lifeline.

People who get food stamps -- 30 million and growing -- will get more. People drawing unemployment checks -- nearly 5 million and growing -- would get an extra $25, and keep those checks coming longer. People who get Supplemental Security Income -- 7 million poor Americans who are elderly, blind or disabled -- would get a one-time extra payment of $250.

Many low-income Americans also are likely to benefit from a trifecta of tax credits: expansions to the existing child tax credit and Earned Income Tax Credit, and a new refundable tax credit for workers. Taken together, the three credits are expected to keep more than 2 million Americans from falling into poverty, including more than 800,000 children, according to the private Center on Budget and Policy Priorities.

The package also includes a $3 billion emergency fund to provide temporary assistance to needy families. In addition, cash-strapped states will get an infusion of $87 billion for Medicaid, the government health program for poor people, which should help avoid cuts to benefits for the needy.

Obama Outlines Plan To Slash 'Wasteful' Spending

by Deborah Tedford

  

 Gerald Herbert

Sen. John McCain (R-AZ) looks on as President Obama makes remarks Wednesday about White House proposals to overhaul the way the government solicits contracts. AP 

NPR.org, March 4, 2009 · President Obama signed a directive Wednesday that changes the way government contracts are awarded and who can get them, a move he said could save as much as $40 billion a year.

The amount the government spends on contracting has ballooned over the past eight years, with outlays for goods and services increasing from $200 billion in 2000 to more than $500 billion in 2008. The president said his plan would make the contracting process more competitive and accessible to independent contractors — and more difficult for contractors to defraud taxpayers.

"It's time for this waste and inefficiency to end," the president said Wednesday morning at the White House. "It's time to invest only in what works."

Obama said his administration would stop hiring private contractors to perform work that government employees could handle. In addition, he pledged to open the process to small businesses and eliminate "unnecessary" no-bid contracts. The plan also strengthens oversight of contracts to cut overruns and fraud.

White House Budget Director Peter Orszag and Cabinet officials will have new guidelines for contracting ready by the end of September, Obama pledged.

On the hot topic of defense spending, the president said he would draw a line between spending that keeps Americans safe and money that largely enriches defense contractors.

Last year, a Government Accountability Office study of 95 major defense acquisitions projects found cost overruns of 26 percent, totaling $295 billion over the life of the projects. Obama said investing in proven technologies and increasing oversight would make the defense contracting system more efficient.

Cost overruns on defense contracts came up last week at the White House summit on the economy, when Arizona Sen. John McCain used the president's fleet of Marine One helicopters as an example. Obama said he had already spoken to Defense Secretary Robert Gates about the fleet of 28 helicopters costing $11.2 billion over budget.

Obama also endorsed a bipartisan effort by McCain and Sen. Carl Levin (D-MI) to change defense procurement and asked Gates to work with the two on legislation that would end the cost overruns common in defense projects.

"The days of giving defense contractors a blank check are over," Obama said.