CHAPTER 15 Government and the Economy: Fiscal and Monetary Policy

AGENDA Wed 4/11 & Thurs 4/12  Review HW (pg 350 #1-6; pg 353 #1-5)  QOD #27: Rising Up  Intro to Fiscal Policy  Expansionary Fiscal Policy  Keynesian Economics  Contractionary Fiscal Policy  Capitalism & Debt  EC #2  HW: pg 403 #1 a-f; #2-5  EC #2 DUE: Thurs 4/19 & Fri 4/20

QOD #27: Rising Up  As the inflation rate increases, the unemployment rate decreases; and when inflation rate decreases the unemployment rate increases.  Explain why this happens.  Prices go up, Revenues go up  Employers can afford to hire more workers  Real world data supports this view: In the 60’s, inflation and unemployment moved in opposite directions. In the 70’s, the inflation unemployment trade-off disappeared for a few years.

What is Fiscal Policy?  Fiscal Policy: Changes government makes in spending or taxation to achieve particular economic goals.  Types of Fiscal Policy:  Expansionary fiscal policy: Government spending is increased, taxes are reduced, or both. Can cause crowding out Example:  Contractionary fiscal policy: Government spending is decreased, taxes are raised, or both. Can cause crowding in Example:

Expansionary fiscal policy and unemployment  High unemployment is due to people not spending enough money in the economy.  If people spend more money  firms sell more goods  and they have to hire more people  to produce more goods.  To reduce the unemployment rate Congress should implement expansionary fiscal policy.  increase govt spending and/or lower taxes

How can gov’t increase spending?  Infrastructure Infrastructure  Education Education  Military (National Defense) Military (National Defense)  Healthcare Healthcare  Transfer Payments (Social Security/Welfare) Transfer Payments (Social Security/Welfare)  Net interest on national debt Net interest on national debt

How does this help?  Increasing government spending will increase money in the economy.  As a result there will be  an increase in total spending  firms will sell more goods  and need to hire more workers.

Keynes on the Economy  John Maynard Keynes was considered one of the greatest economists of all time. He argued that too little spending in the economy was the cause of high unemployment.  He also was a vocal dissenter to WWI reparations.  Before Keynes, most thought firms would lower prices to increase people to spend/buy.  However, Keynes argued: Low spending does not lead to lower prices  Businesses will cut jobs before they lower prices

Keynesian Critics  Critics argue that Keynes, in his promotion of expansionary spending, does not take into account “crowding out.”  Govt spends more, consumers/businesses spend less  Therefore, there will be little change in total spending.  Do you agree/disagree? Why?

Contrationary Fiscal Policy and Inflation  Economists argue that the way to lower prices in the economy is to reduce spending using contractionary fiscal policy (decreasing govt spending, raising taxes, or both)  Inflation is the result of too much spending in the economy. Government decreases spending = less spending in the economy decrease in total spending = firms initially sell fewer goods As a result of selling fewer goods, firms have surplus goods on hand. What happens when there is a surplus of goods? Prices go down!

References  Arnold, R (2001). Economics in our times, 2nd edition. Chicago, IL: National Textbook Company. 