1. Chapter 17 Stabilizing the National Economy

2. Chapter Objectives  Understand why unemployment and inflation are two major threats to a nation’s economic stability (17-1)  Know how government taxation and spending can stimulate/slow economic growth (17-2)  Understand the theory used by the Fed that controls the money supply to stabilize the economy (17-3)

3. Measuring Unemployment  UNEMPLOYMENT RATE  Percentage of civilian labor force that is unemployed BUT actively seeking work  One of the statistics used to measure the health of our economy  REMEMBER…not everyone is included in the labor force  Students, retirees, long-term hospital patients  Four distinct types of unemployment

6. Inflation

7. Demand-Pull Inflation  Prices rise as the result of excessive business & consumer demand  Demand increases faster than total supply  Results in shortages  Leading to higher prices  Basically, creates a “bidding war” over goods due to a shortage  Thus DEMAND for goods PULLS the prices up

8. Cost-Push Inflation  Higher wages push prices up  Inputs (wages) increase  Production cost rise  Price of goods increases to compensate  Rising COST PUSH price levels up  STAGFLATION  Combination of inflation and stagnation  Stagnation is low economic activity

9. Circular Flow of Income & Output  FISCAL POLICY  Federal government’s use of taxation & spending policies to affect overall business activity  John Maynard Keynes  Developed fiscal policy theories during the Great Depression  Believed forces of aggregate supply/demand moved to slowly  Government should help stimulate aggregate demand

10. Circular Flow of Income & Output  Economic model that pictures income as flowing continuously between businesses & consumers  Not all income follows the circular flow  LEAKAGES  Money that leaves the circular flow  Savings & Taxes  INJECTIONS  Money that enters the circular flow  Business Investments & Government Spending

12. The Supply-Side Effects  Opposite Keynesian Theorist  Believe in  Less government involvement  Less Taxes  Leave more money IN the economy  Used to stimulate private investment  Grow our employment levels

13. The Supply-Side Effects  Named this way because…  They affect the supply of key ingredients of economic growth  President Bush used this argument to promote his “Jobs & Growth Tax Act” (‘03)  Features were aimed at increasing economic growth  Tax rates fell effective January 2003  Highest tax rate fell from 39.6% to 35%  Tax on dividends fell from 39.9% to 15%  Capital Gains tax fell from 20% to 15%  Low-Income earners tax rate fell to 5%

14. Monetarism  Theory that deals with the relationship between the amount of money the Fed places in circulation and the level of activity in the economy  Often tied to economist Milton Friedman  Believe the money supply should be used to influence the economy  Fed increases the money supply at a given percent each year

15. Monetarism  Argue that too much money released too quickly will  Force the economy to expand too rapidly  Encourage people to borrow more & spend more  Which will…  Raise outputs & businesses will hire more workers  Bring down unemployment  However if we are already at full employment  This will cause prices to rise  Inflation will occur

16. Government Policy Interpreted by Monetarists  Friedman (monetarists) believe the economy is too complex & misunderstood  Government does more harm than good  Should be left up to businesses & consumers  Oppose Fiscal Policy to stimulate/slow economic growth  Believe the Fed should stop trying to smooth the ups & downs of the economy

17. Monetary Rule  The fed should allow the money supply to grow at a smooth, consistent rate per year and not use monetary policy to stimulate/slow the economy  Believe in steady growth with strict guidelines  Best way to provide businesses/consumers with more certainty in an economic future  Result would be controlled expansion

19. Monetarists’ Criticism of Fiscal Policy  Cannot be implemented effectively  No single government body designs & implements  President recommends course of action  Congress enacts fiscal policy  Politicians may make decisions today to get reelected  May hurt economy in long run  Time Lags  May take months or years for policy to stimulate the economy