MACRO ECONOMIC GOVERNMENT POLICY

NATIONAL ECONOMIC POLICY GOALSSustained economic growth as measured

by gross domestic product (GDP)GDP is total amount of goods and services

produced in the US each yearLow inflationFull employment

UNEMPLOYMENT

Measured by the Bureau of Labor Statistics

Definition “members of the labor force who are looking for work, but unable to find jobs.”

Unemployment rate = % unemployedEstimate is low - “discouraged workers”

not included

INFLATION

Defined as the sustained rise in pricesMeasured by the Consumer Price Index

(CPI)Inflation reduces purchasing power of

consumersComparing real GDP between years

means accounting for inflation (GDP deflator)

BUSINESS CYCLE

Periods of GDP growth are called expansions or boom periods

6 months of falling GDP is called a recession.

Severe GDP drop is depressionTop of the business cycle is peakBottom recession called trough

FISCAL POLICY

Government tax and spending policies designed to stimulate or contract GDP

During recession government seeks to use stimulatory fiscal policy

During an expansion and rising prices government seeks to use contractionary fiscal policy

KEYNESIAN ECONOMICS

John Maynard Keynes called for increased government spending and tax cuts during the Great Depression

Keynesian economics focuses on government tax and spending policies

STIMULATORY FISCAL POLICY

Goal is to increase employment and GDP during a recession

increase government spendingTax cuts also stimulates consumer

spending and business investmentConsumption up + Business Investment

up + Government up +NX = GDP up

CONTRACTIONARY FISCAL POLICYDesigned to bring inflation downGovernment spending decreasesTax increases

AUTOMATIC STABILIZERS

Unemployment insurance goes up during a recession, therefore consumption is maintained even with unemployment

During a recession taxes decline due to progressive tax policy

During an expansion taxes increase as consumers and businesses generate more income.

GOVERNMENT BORROWING

Keynes believed that during a recession governments should deficit spend to fund programs (not increase taxes)

Governments borrow by selling Treasury bills.

T-bills are purchased by wealthy individuals, businesses, and foreign investors

NATIONAL DEBT

In recent years national debt has increased.

Clinton years government ran a surplus due to tax increases and the dot.com expansion

Bush years government ran a deficit and national debt increased due to tax cuts and financing war in Iraq.

MONETARY POLICY

US government can expand money supply during a recession or contract money supply during an expansion

Money supply is controlled by the Federal Reserve Banks

FEDERAL RESERVE BANK

14 districtsFederal Reserve chairman - Benjamin

BernankeFederal Reserve

MONEY SUPPLY

Total amount of money circulating in the economy

Money supply is determined by the federal reserve banks

“LOOSE” MONEY

Federal reserve can expand the money supply during a recession by

1. Lowering reserve rate required for member banks

2. Lowering rediscount rate (interest rate charged by the Fed)

3. Buying Bonds, which puts more money in bond holders hands

“TIGHT” MONEY

Federal Reserve can try to slow down inflation by:

1. Raising reserve rate2. Raising rediscount rate3. Selling bonds, which takes money out of

the private economy

TIME LAG PROBLEM IN ECONOMIC POLICYThe problem with government economic

problem is that each policy takes time to work.

Often by the time the problem is diagnosed and fiscal or monetary policy are in place the economy has changed.

This is called the “time lag” problem.

Taxes

Largest source of government income is individual income taxes

US has progressive income tax structure (wealthier groups pay higher percentage)

Social Security taxes (FICA) are tax on wages

Additional taxes include: corporate taxes, estate taxes, state income tax, sales

Social Security

Passed during Depression to create a pension for all Americans

6.2 % of incomeNot a fund, current workers pay for retiring

workersRatio of retiress to workers rising,

therefore long term not enough to cover retirees

Solutions to Social Security

Increase social security taxGet rid of income cap on taxesIncrease age of beneficiariesPrivatize social security to make IRAIncrease immigration to increase

percentage of current workers to retirees

World trade

US imports 14% of GDPExports 12% of GDPLast several years, US running large trade

deficits (value of imports higher than exports)

Some Americans suggesting tariffs (taxes on foreign goods) or quotas on foreign goods to reduce imports.

Free Trade versus Protectionism

Free Trade advocates say US benefits from lower prices on foreign goods and the ability to export US products to foreign countries

Protectionists argue US not being treated fairly in foreign markets and are losing important jobs at home to foreign competition.

Globalization and Trade Organizations

World Trade Organization (WTO) - 140 member countries monitors and negotiates trade disputes

North American Free Trade Organization (Canada, US and Mexico)

European Union (EU)