Policy Making— Economic Policy --The Government’s Role --Theories of Economic Policy --The Budget --National Debt 1

Economic Policy—The Government’s Role I. Ways in which the national government can affect the economy A. Fiscal Policy: taxing and spendingFiscal Policy 1. Political Actors who play a role in making these choices: a. Congress: i. House and Senate Budget Committees: set annual budget targets ii. House and Senate Appropriations Committees: allocate spending (porkbarrels) iii. House Ways and Means Committee: taxing powers (must originate in House) iv. Senate Finance Committee: considers tax proposals begun in House Ways and Means Committee b. President: i. Council of Economic Advisors: Located in EOP, has 3 members who advise the president on economic policy ii. Office of Management and Budget (OMB): Located in the EOP, prepares the President’s budget proposals iii. Secretary of the Treasury: Tries to represent the point of view of the business community, creates estimates of what revenues will be from current tax policies (or changes to those policies). 2

Economic Policy—The Government’s Role I. Ways in which the national government can affect the economy (cont.) B. Monetary Policy: Regulating a) the supply of money and b) interest rates 1. Political Actors who play a role in making these choices: The Federal Reserve System (“The Fed”) a. Independent body b. Missions of The Fed: i. Regulate the supply of money in the economy ii. Regulate the “price” of money (through interest rates) c. 7 members, appointed by the president (confirmed by the Senate) i. 14-year, nonrenewable terms (can’t be removed except for cause) 2. The Fed at work—a simplified story (think of “the money spigot”): a. Too much money in the economy = inflation i. Solution = raise interest rates b. Too little money in the economy = recession ii. Solution = lower interest rates 3

Economic Policy—Theories I. Theories on the Government’s Role in the Economy A. Monetarism: government’s limited role should be to simply increase the money supply in a steady, predictable manner tied to productivity increases 1. Economy suffers from “start-and-stop” government spending 2. Strongly support free market (little government intervention) 3. Example: Milton Friedman. Theory is popular with conservatives. B. Keynesianism: government should play an active role in maintaining the economic demand for goods and services 1. When public demand is too low (recession), government should spend into deficit to pump more money into the economy 2. When public demand is too high (inflation), government should raise taxes or cut spending 3. Example: John Maynard Keynes. Theory is popular with liberals. 4

Economic Policy—Theories I. Theories on the Government’s Role in the Economy (cont.) C. Economic Planning: government should be so involved as to plan some part of the country’s economic activity (such as wage and price controls, or directing investments to certain industries) 1. Little faith in the operation of the free market 2. Example: John Kenneth Galbraith. Theory popular with socialists. D. Supply-Side Tax Cuts: government should limit its role by cutting taxes 1. Lower taxes will increase incentives to work, save, and invest 2. Greater economic productivity will ultimately produce more tax revenue a. Even though tax rates are lower, overall tax income will be higher 3. Example: Arthur Laffer. Theory popular with conservatives. a. “Reaganomics”: Combination of Supply-Side, Monetarism, and domestic spending cuts. i. PROBLEM: Military spending skyrocketed—huge gap between spending and tax revenues = huge budget deficits. ii. Reagan’s policies ended up being Keynesian—government spent into deficit and economic performance increased. 5

Economic Policy—Goals I. Conflicting economic goals of governments A. Lower interest rates or lower inflation? 1. Lower interest rates makes money more accessible a. More money leads to more investment, more economic activity 2. More money can lead to inflation a. Inflation eats away at economic value b. Governments fight inflation by raising interest rates B. Partisan Economic Differences: Both Republicans and Democrats want low unemployment and low inflation 1. Full-employment policies can oftentimes lead to inflation. If the parties must choose: a. Democrats tend to fight unemployment b. Republicans tend to fight high inflation 6

Economic Policy—Budget I. The National Budget: Income and Expenditures A. Government Income: Taxes 1. Income Tax is largest sourcelargest source a. U.S. income taxes are progressive in formprogressive b. Other forms of taxesforms of taxes B. Government Expenditures—2 types: mandatory and discretionaryGovernment Expenditures 1. Mandatory: Funding established by law, government is legally required to pay a. Payments on the national debt b. “Entitlements”: Social Security, Medicare, Medicaid, Social Welfare i. Definition: A claim for government funds that cannot be changed without violating the rights of the claimant 2. Discretionary: Funding set as part of the annual budgeting process a. National Defense b. Basically everything else that the national government does i. “Department of…” 3. Relative size of Mandatory vs. Discretionary SpendingMandatory vs. Discretionary Spending 7

Economic Policy—The Debt I. When Expenditures Exceed Income—Definitions: 1. Deficit: this occurs when the government spends more money than it takes in from taxes in one year 2. National debt: the total of all the deficits (the total of all the money owed by the national government) II. The National debt A. Growth Over Time. Should we be worried?Growthworried 1. Best measure is to compare debt to size of the economy (% of GDP)compare debt to size of the economy a. Gross Domestic Product (GDP): The amount of goods and services produced by a country in one year. B. How to lower the national debt 1. Increase taxes a. Increase it on whom? 2. Cut spending a. Cut spending for whom? b. How much can you cut? Role of “entitlements” (mandatory spending)mandatory spending c. “Sequesters” = automatic spending cuts 8