Government in the Macroeconomy There are two kinds of policy that the government has used to influence the macroeconomy: 1.Monetary policy 2.Fiscal policy

Government in the Macroeconomy Monetary policy consists of tools used by the Federal Reserve to control the quantity of money in the economy. Fiscal policy refers to government policies concerning taxes and spending. Controlled by the President and Congress.

The Federal Reserve System, or the Fed, is the central bank of the United States. It is a banker’s bank.  When banks need money, they borrow from the Fed.  The United States is divided into 12 Federal Reserve Districts.  Each has one main Federal Reserve Bank and most have branch banks. Monetary Policy

The President appoints the seven members of the Board of Governors and selects one to chair the board for a four-year term.  The board is independent of the President and Congress.  This allows it to make economic decisions free from political pressure. OBVIOUSLY…The Chairmen of the Federal Reserve is very powerful since they control the nation’s money supply! Structure and Organization (cont.)

Functions of the Fed (cont.) The Fed also acts as the government’s bank.  The government deposits revenues in the Fed and withdraws it to buy goods.  The Fed sells U.S. government bonds and Treasury bills, which the government uses to borrow money.

What are three ways in which the Fed acts as the government’s bank? The Fed holds the government’s money, sells government bonds and Treasury bills, and issues (prints) the nation’s currency. Functions of the Fed (cont.)

Monetary Policy Monetary policy involves controlling the supply of money and the cost of borrowing money according to the needs of the economy.  Tools Used By the Fed The interest rate is what people and businesses must pay a lender (like a bank) to borrow money OR what banks PAY YOU to keep your money in their bank.  The Fed can change interest rates.

U.S. Interest Rate History

The discount rate is the rate the Fed charges member banks for loans.  If the Fed wants to stimulate the economy, it lowers the discount rate.  Low rates encourage banks to borrow from the Fed to make loans to their customers.  To slow the economy, the Fed raises the discount rate to discourage borrowing.  This contracts the money supply and raises interest rates. Conducting Monetary Policy (cont.)

Member banks must keep a certain percentage of their money in Federal Reserve Banks as a reserve.  The Fed can raise the reserve requirement to reduce the money banks have available to lend.  It can lower the reserve requirement to increase the money banks have to lend. Conducting Monetary Policy (cont.)

14-14 Loose Monetary Policy If the Fed implements a loose monetary policy (expansion), the interest rates are lowered, and discount rates/reserve requirement falls. A loose money policy is often implemented as an attempt to encourage: Consumer spending and investment by businesses which will lead to economic growth.

14-15 Tight Monetary Policy If the Fed allows a tight monetary policy, the interest rates are raised, and discount rates/reserve requirement increase. Why would any nation want a tight money policy? –In order to control inflation and slow economic growth

14-16 The Two Faces of Monetary Policy

Copyright © 2005 Pearson Addison-Wesley. All rights reserved Open Market Operations This term refers to the Fed changing the amount of reserves in the banking system by its purchases and sales of government securities issued by the U.S. Treasury.

Open Market Operations Treasury bonds, notes, and bills are promissory notes issued by the federal government when it borrows money. Corporate bonds are promissory notes issued by corporations when they borrow money (the promise to repay).

What are three ways that the Fed can increase the money supply? To increase the money supply, the Fed can lower the discount rate, reduce the reserve requirement, or buy government bonds from investors. Conducting Monetary Policy (cont.)

Section 2: The Federal Reserve System The Federal Reserve wields a great deal of power in our economy. It serves as the nation’s central bank, it controls monetary policy, and it regulates commercial banks.

The Business Cycle The business cycle is the cycle of short- term ups (growth) and downs (decline) that the economy normally experiences. The economy expands, reaches a peak, and then declines into a recession before expanding again. - Expansions are generally longer than recessions.

Business Cycle A recession is a period during which output declines. Two consecutive quarters (6 months) of decrease in output signal a recession. A prolonged and deep recession becomes a depression. Policy makers attempt to avoid depression by using fiscal and monetary policies.

The Business Cycle

Conducting Monetary Policy (cont.) If the Fed lowers the interest rate, it expands the money supply, which moves the supply curve to the right.  It raises the interest rate, to reduce the money supply, which shifts the supply curve to the left.  The Fed can manipulate the money supply through the discount rate, reserve requirement, and interest rates.

The Components of the Macroeconomy The circular flow diagram shows the income received and payments made by each sector of the economy.

19.2 – Economic Activity and Productivity. Circular Flow – Flow of resources, goods and services in a market economy.

The Circular-Flow Diagram Market for Factors of Production Market for Goods and Services SpendingRevenue Wages, rent, and profit Income Goods & Services sold Goods & Services bought Labor, land, and capital Inputs for production FirmsHouseholds

The Government’s Role: the Command Aspect in the Market Economy The Government plays an important role in regulating our economy. Pay attention to the ways in which the Government helps to maintain economic growth in periods of recession and slows growth in periods of expansion.

Economic Policy U.S. Economic Goals (1946) - full employment economic growth wage and price stability

Fiscal Policy John Maynard Keynes ( ): Keynesian Theory - Use government spending to offset economic decline in private spending and help maintain: levels of spending production employment.

Keynesian Theory Exercised by Congress and President Tools: taxing and spending - use federal revenues (taxes) and federal spending to achieve economic goals.

Supply-Side Economics AKA “Reaganomics” Intro – 1980’s

Supply-Side Economics in the 1980s 1) tax cuts for business to provide incentives for firms to produce, and tax cuts for households to promote the incentive to work. 2) Shift in government spending away from social programs (including job training and education) to military spending — but no net decrease in government spending

Supply-Side Economics in the 1980s 3) Deregulation of industry and financial institutions—to cut costs, promote efficiency, and remove cumbersome laws and regulations. Trickle down effect- If the rich do well, benefits will "trickle down" to the rest. Lower taxes on high income or capital gains will benefit most of the population, etc.

Federal Regulation of the Economy In the 1960s and 1970s our government turned to business regulations. Business regulations controls business behavior by establishing rules. Affects many areas to protect consumers and citizens from a variety of threats like the quality and safety of products. Agencies were created such as the Consumer Product Safety Commission Occupational Safety and Health Administration Environmental Protection Agency National Transportation Safety Board

Why regulation? Promote competition Market fairness – Protect against abuses by industry Consumer protection Safety in the workplace Improved service, range and quality Improved efficiency and lower prices

Deregulation The removal or simplification of government rules and regulations that limit the free market forces. Deregulation does not mean elimination of laws against fraud, but eliminating or reducing government control of how business is done, thereby moving toward a more free market. Page 5 Sept 1-3, 2001

What Are the Disadvantages of Deregulation? Foreign Ownership Failure to monitor activities of businesses which could lead to dangerous economic pratices. Page 19 Sept 1-3, 2001 What Are the Advantages of Deregulation? More Competition & Thus Cheaper Rates for Consumers Better Services – Customers receive Better Prices and Better Basic Services

What are the big risks? Blatant Disregard for Rules Immoral or Inappropriate Activity Misunderstandings Conflicting Priorities Over Compliance? Lack of Support – Bureaucracy

Government’s Role In Our Economy Main Idea The federal government manages the economy by keeping track of the health and adjusting its performance. The government also decides how best to spend the public money it collects in taxes and fees. Key Terms Inflation Gross Domestic Product Federal Budget Deficit Surplus National Debt

SAVING is the part of a person’s income that is not spent for goods and services or used to pay taxes. INVESTING occurs when people and businesses use money to purchase capital goods or increase the skills and abilities of workers.

Foreign Sector We sell products to, and buy products from, other countries. Accounts for less than 4 percent of GDP.

Government Sector Made up of the Federal, State, and local governments. 20 percent of GDP Receives revenue from the Factor Markets (public universities charging tuition) and taxes. Government also purchases goods and services in the product market (fighter planes).

Product Markets Where people spend their money. Here, producers offer goods and services for sale. Part of the business sector (which is smaller than the consumer sector).

Factor Markets Markets where productive resources are bought and sold. Here, workers earn wages in exchange for labor. Part of the consumer sector.