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Monetary Policy & Fiscal Policy
Putting Oomph in the C and I of the GDP
Monetary Policy -
What the Federal Reserve can do to “fix” the economy.
– Consumption and Investment
Works to keep monetary inflation under control
Fight demand – pull inflation with controlling the interest rates.
The Goals of the Federal Reserve
Regulating the money supply Serving as the government’s bank Supervising FDIC banks.
– Clearing checks– loans
The Money Supply: Types of Money
M1: Money that is readily made into cash or is cash.
M2: M1 + savings CDs, money markets, savings deposits.
M3 and L: M1 + M2 + large CDs, stort term treasury bonds and other“near money.”
050
100
1st
Qt
r
East
West
North
Monetary Policy and Aggregate Demand
Easy Money Policy
Low interest rates, makes money cheap. Increases C and I.
Tight Money Policy
Higher interest rates makes money expensive.
Decreases C and I.
Ben Bernanke’s Economic Tools
Open Market Operations.
Discount Rate Prime rate Reserve Requirements
Open Market Operations
If Bernanke wants to get more money into the economy he BUYS government bonds from banks. – Banks have more money to loan to customers.– People then have more money to consume and
invest.
Discount Rate
The interest rate that the Fed charges to banks. – The Fed raises the discount rate. The banks pass
the increase on to customers. Money is more expensive for customers as interest rates
go up. THE PRIME RATE.
Main Types of Interest Rates in 2009
Discount Rate– How much it costs to get money
from the Fed .5% (2009) 2.25% (2008)
Fed Funds Rate– How much money it costs to get
money from other banks. .25% (2009) 2% (2008)
Prime Rate– Best rate for best customers.
3.25% (2009) 5.0% (2008)
Reserve Requirement
Money that must be held by banks in their vaults or at the Fed. -Raise the reserve requirements on a bank. They
have LESS money to loan to customers. Less money is available – it makes the price of money (the interest rate) go up. SCARCITY. Makes C and I go down. -BUT THESE RESERVES ARE WHAT IS MEANT TO BACK UP FAILED BANKS!
Federal Reserve Problems?
Economic forecasting might not be quite correct.
Ben Bernanke’s priorities might not be the publics.
Lack of coordination with fiscal policies.
Special Issues for banks in 2009
New powers for the Fed Chair
Stress Tests Bank Failures Getting credit going in
the marketplace again.
Did Bernanke realize things could go wrong in February 2008?
February – July 2008, the federal government granted Chairman Bernanke “extraordinary” powers that had once been Congress’ domain in the economy.
Bernanke’s new powers
The Federal Reserve should have a much larger role in supervising investment banks to prevent and limit financial market turmoil, Federal Reserve Chairman Ben Bernanke said, endorsing an expansion of the central bank's authority into new territory.
Bernanke’s Argument for the Fed Powers
"Holding the Fed more formally accountable for promoting financial stability makes sense only if the institution's powers are consistent with its responsibilities," Bernanke said.
Congress should consider giving the Fed power to set standards for capital liquidity holdings and risk management for investment banks, as it now does for commercial banks
October 2008
Bernanke talked to the President and Congressional leadership in a 45 minute private meeting.
October 2008 - Present
Chairman Bernanke and Secretary of the Treasury Geitner have extraordinary powers to intervene in the economy.
– Stimulus money injections– Regulation of banks /
corporations– Controlling of
corporations?
Stress Tests
Banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.
– DO THEY HAVE THE RESERVES TO SURVIVE?
Stress Tests
The average outlook of private-sector forecasters envisions the economy shrinking by 2 percent this year and unemployment peaking just below 9 percent in 2010.
The average forecast for housing prices is a decline of 14 percent this year and an additional 4 percent next year.
Economic Forecasting by the Fed?
Recent forecasts by the Federal Reserve and most private forecasters have undershot the severity of the downturn.
Bank Failures
29 so far in 2009! 57 failures (1998 – 2008) DOES THE FED HAVE
ENOUGH MONEY?
Fiscal Policy and the Economy
How does the President and Congress affect the economy?– Control of tax rate.
Proportional taxes (flat tax) – say 5% of everyone’s income whether you or Bill Gates.
Progressive taxes – Richer should pay more. Luxury taxes. Regressive taxes – Taxes the poor tend to pay more.
Lottery tickets, cigarette taxes.
Taxes
Majority of revenue for the US is through income tax. 45.2%
– Second is Social security taxes and contributions. 35%
– Third is corporate taxes. 11%
Recession
People have the money but don’t spend it.
Unemployment goes up. GDP slows.
Fiscal Cures for Recession
Change the tax rates.– Puts more money in the economy for Consumption
and Investment.
– Government Spending. Unemployment benefits, money for projects like roads, building improvements.
Problems of Fiscal Policies
Timing Problems. Might trigger inflation.
Political Pressures. Lack of coordination. Unpredictable economic
behaviors. – What worked in the past
might not work now.
Problem of Fiscal Policy in 2009: The Deficit
When government SPENDS (outlays) more than they TAKE IN (receipts) in taxes for the year – DEFICIT.
Projected 2009 deficit is -$490 Billion to 1.8 TRILLION.
Debt v. Deficit
In 2009 the government will spend somewhere between 490 billion to 1.8 trillion more than it takes in revenue. (DEFICIT)
US Debt is at http://www.brillig.com/debt_clock/– Or google US debt clock.
What is causing the deficit?
Higher government expenditures
– War in Iraq / Afghanistan– Government needs – Lack of taxes being
collected due to Recession Too many tax cuts in the
early 2000’s
Governments typically engage in deficit spending
Developed by economist John Maynard Keynes (1883 – 1946) to help get government out of the Great Depression (1930s)
Keynsian Economics
Fiscal Policy where it is more important to get the people of the country working.
Government goes into debt to employ people or give them benefits until they can find a job.
Keynsian Economics
IMPORTANT POINT!!! Okay to go into debt when
times are bad.– People are employed, they
begin to consume and invest again.
– Then government can collect taxes.
– WHEN TIMES ARE “GOOD” UP THE TAXES TO GET READY FOR THE NEXT “BAD” TIME.
US Government has not remembered that final rule of Keynsian Economics.
When times were good in the 1990s – taxes were cut.
Why be worried about the debt?
The interest we have to pay for the debt takes away from money we could spend on other things:
– Schools– Roads– Health care– Infrastructure
What should be the fiscal goals of government?
Stability- unemployment, inflation Equity - inequality, fairness Sustainability – resource use, balance Growth- per capita GDP, living
standard Flexibility – ability to change and adapt … : other needs of the society
The President’s Powers in Fiscal Policy
Budget proposals; program proposals
Veto power; may refuse to spend
Congress’ Powers in Fiscal Matters
May amend/ must approve budget
Propose programs Power of the purse
Govt. spending breaks down to two types:
Nondiscretionary / Mandatory. Taxing and spending programs enacted by a previous administration.
– TRANSFER PAYMENTS: Discretionary.
Programs making deliberate changes in taxes and spending.
GOALS OF FISCAL POLICY IN 2009?
Most fiscal policies are focused on Growth and Stability. Such policies aim for one of two general effects:
Increase output and employment– Contractionary– Expansionary
Expansionary Policy
Increase spending Increase transfer
payments Decrease taxes
Expansionary Goals
Reach Potential Output
Reach Full Employment
Control inflation Stimulate growth
Contractionary Goals
Reach Potential Output
Reach Full Employment
Control inflation Stimulate growth
Contractionary Policies
Decrease government spending
Decrease / Level transfer payments
Lower / Raise Taxes– More regressive taxing?