Chapter 16: Financing Government Section 4

Objectives Describe the overall goals of the Federal Government’s actions in the economy. Explain the features and purposes of fiscal policy. Explain the features and purposes of monetary policy.

Key Terms gross domestic product: the total value of all goods and services produced in a country each year inflation: a general increase in prices throughout the economy deflation: a general decrease in prices throughout the economy recession: an absence of GDP growth and a shrinking economy fiscal policy: the government’s powers to tax and spend to influence the economy

Key Terms, cont. monetary policy: the government’s power to influence the economy by regulating the money supply and the availability of credit open market operations: the process of buying or selling government securities from the nation’s banks reserve requirement: the amount of money that the Federal Reserve Board says banks must keep on reserve discount rate: the rate of interest a bank must pay when it borrows money from a Federal Reserve bank

Introduction How does the Federal Government achieve its economic goals? The Federal Government tries to maintain a healthy, growing economy through a combination of fiscal policies. These involve taxation, government spending and monetary policies based on controlling the money supply and the availability of credit. 5

Overall Economic Goals The federal government seeks to achieve full employment, price stability, and economic growth. Full employment means that everyone able and willing to work can find a job. Price stability means that overall prices for goods and service do not rise too high (inflation) or fall too low (deflation). Economic growth means that the gross domestic product (GDP) steadily increases, avoiding recession.

Overall Economic Goals, cont. Checkpoint: How can inflation and deflation affect the economy? High inflation means that dollars buy less than they previously did, which robs people of purchasing power. Deflation hurts the economy by making it harder to borrow money and lowering the money earned by farmers and other producers, who receive less for their goods. Checkpoint Answer: Inflation lowers purchasing power, hurting consumers. Deflation lowers earning power, hurting producers, as well as making it harder to borrow money. 7

Fiscal Policy Fiscal policy is the government’s attempt to influence the economy through taxation and spending. In general, higher government spending increases economy activity, while less spending dampens activity. Tax increases tend to slow economic growth, while tax cuts boost growth. For many years, federal fiscal policy was limited. Very little of GDP came from federal spending. Today, federal spending accounts for about 20% of GDP.

Fiscal Policy, cont. During economic downturns, policy makers usually increase federal spending, cut taxes, or both in hopes of expanding the economy. In theory, tax increases or cuts in federal spending can slow inflation. NOTE TO TEACHERS: The above image shows President George W. Bush signing the 2008 Economic Stimulus Act.

Monetary Policy Monetary policy involves increasing or decreasing the money supply and easing or tightening the availability of credit. The goal is to boost or slow down the economy as needed. The seven-member Federal Reserve Board, or Fed, carries out U.S. monetary policy. Members are appointed to 14-year terms. The Fed also helps stabilize the banking system by providing emergency funding.

Monetary Policy, cont. Under the guidance of current Chairman Ben Bernanke, the Fed has three major tools for altering the money supply: Open market operations Reserve requirements The discount rate NOTE TO TEACHERS: The above image shows Federal Reserve Chairman Ben Bernake. 11

Open Market Operations The Federal Reserve carries out open market operations by buying or selling government securities to and from banks. Buying government securities gives banks more money to loan to individuals and businesses. This can boost business activity. Selling government bonds to banks removes money from circulation, leaving banks with less money to loan or invest. This slows business activity.

Reserve Requirements The reserve requirement is the amount of money that the Federal Reserve requires banks to keep in their vaults or on deposit with one of the 12 Federal Reserve Banks. Money kept in reserve cannot be loaned or spent—it is out of circulation. Increasing the reserve requirement lowers the amount of money in circulation, while decreasing the reserve requirement does the opposite.

The Discount Rate The discount rate is the interest paid by banks borrowing from the Federal Reserve. Raising the discount rate slows borrowing, which reduces the flow of money. Lowering it does the opposite. How does this cartoon show the complexity of monetary policy? Political Cartoon Question Answer: The cartoon implies that trying to find the proper balance between economic growth and interest rates is very difficult, because lowering one tends to raise the other.

Review Now that you have learned about how the Federal Government achieves its economic goals, go back and answer the Chapter Essential Question. How should the federal budget reflect Americans’ priorities?