Achieving Economic Stability Chapter 16

Goals & Objectives 1.Eco nomic & Social Costs of Instability. 2.Aggregate Supply & Demand. 3.Macroeconomic equilibrium. 4.Operations & impact of fiscal policy. 5.Basic assumptions of monetary policy. 6.Monetary policy conflicts. 7.Differing economic viewpoints. 8.Politics and economics interaction.

The Cost of Economic Instability  Characteristics of instability: 1.Recession 2.Unemployment 3.Inflation  Stagflation: stagnant GDP with inflation.  GDP Gap: actual (JIT) vs. potential production possibility (JIC production)  Misery Index or Discomfort Index: sum of monthly inflation & unemployment rates

Stagflation (Impossible?)

Misery or Discomfort Index

The Social Costs 1. Wasted Resources: Unemployed Labor, Idle factories, unused natural resources 2. Political Instability: New political movements (Realignments & Dealignments). Incumbency defeats. 3. Crime & Family Values: no opportunities increases crime & divorce.

Aggregate 1. Aggregate Supply: “assuming” the supply of money is at a constant; the total value of all goods & services or GDP 1. Money Supply 2. Labor Productivity 3. Input Costs

Aggregate 2. Aggregate Demand: “summary” measure of all demand in the economy; total quantity of goods & services at different price levels. Excludes Black Market items. 3. Macroeconomic Equilibrium: real GDP consistent with price levels as determined by the intersection of the supply & demand curve.

Stabilization Policies 1.Demand Side Policies: Fiscal Policy: Governments policy of Taxing and Spending. 1.Designed to increase or decrease total demand. 1.Increase taxes = less income = decreased demand. 2.Decrease taxes = more income = increased demand. 3.Subsidies to producers. Increased or decreased supply. 4.Entitlements to consumers: Increased demand.

Welfare Spending

Fiscal Policy Keynesian Economics: John Maynard Keynes: British Socialist –The General Theory of Employment, Interest, and Money th sector of an economy: Government 2.Short-run or temporary approach of government taxing, subsidizing, and spending to increase or decrease Demand.

Fiscal Policy & Interest Groups

Keynesian Framework 1.Government could take a Direct role in the economy : Public Salary Tax : Public Revenue Act: 1 st payroll tax. 4.Business subsidies. 5.Federal Deficits. 6.Deficit Spending. 7.Inflation Policy

Automatic Stabilizers Key component of fiscal policy: 1. Unemployment Insurance Compensation: 2. Social Security, Welfare, Medicare, Medicaid. 3. Progressive Income Taxation.

Supply-Side Policies 1.Policies designed to stimulate output and lower unemployment by increasing production/supply rather than demand. 1. Deflation Policy: 2.Smaller Role of Government: Fewer federal regulatory agencies. Deregulation. 3.Low Federal Taxes: high taxes creates a diminished incentive to produce or work.

Supply-Side Economics 4. Laffer curve: lower taxes increases the number of workers which increases tax revenues for the federal government. Limitations of Supply-Side Policies: 1. Promotes economic growth rather than creating welfare programs.

Lower tax rate increases government revenue

Monetary Policies Monetarism: role of money and GDP growth. The Federal Reserve and the discount rate: Eliminate fiscal and supply side policies and allow a constant supply of money into the economy without government interference (Politics).

Interest Rates & Inflation 1.Short Run; Expansionist monetary policy: 1. Shift supply curve to the right by lowering interest rates for individuals and business. 2. Slow & Steady money supply to keep inflation low. 2.Politics of Interest Rates & Inflation: 1. Richard Nixon: wage-price controls: Wage- increases illegal. Increased prices permission from the government.

Monetary Policy & Unemployment 1.Two Theories regarding cheap money or low interest rates to keep unemployment low. 1. Excessive rates of monetary growth drive up prices and interest rates. 2. Long term inflation caused by excessive monetary growth.

3 Types of Fiscal Policy 1.Discretionary Fiscal Policy: someone must choose to implement. President or Bureaucrat 1. Recognition lag: Beginning of a recession to the awareness of a recession. 2. Implementation lag: Time to counter a recession. 3. Short duration of recessions (8 months). 4. Political gridlock: Divisive politics surrounding budgetary matters. 5. Budget caps: Designed to limit federal spending.

3 Types of Fiscal Policy 2. Passive Fiscal Policy: gov’t programs and economic stability. 1. Automatic Stabilizers: 2. Progressive Income Taxes: 3. Structural Fiscal Policy: Long term economic planning. 1. Affordable Care Act Welfare Reform Bill 1996

Politics of Monetary Policy Federal Reserve is a private or independent lender & supplier of our nation’s money supply. Monetarist Point of View: Long term solutions with little short term relief. 1. Monetary Growth with Fiscal Policy. 2. Monetary Growth with Supply-Side Policy.

ACA Spending