Presentation on theme: "Taxes, Fiscal, and Monetary Policies"— Presentation transcript:
1 Taxes, Fiscal, and Monetary Policies Unit 7 Macroeconomics:Taxes, Fiscal, and Monetary PoliciesChapters 16.4EconomicsMr. Biggs
2 Monetary Policy and Macroeconomic Stabilization Monetarism - The belief that money supply is the most important factorin macroeconomic performance.How Monetary Policy WorksMonetary policy alters the supply of money which then affects:Interest ratesLevel of investment and spending
3 The Money Supply and Interest Rates When the money supply is low,interest rates are high.When the money supply is high,interest rates are low.Interest Rates and SpendingEasy money policy - Monetary policythat increases the money supply bydecreasing the discount interest rate.It is used to encourage businessinvestment.Tight money policy - Monetary policythat reduces the money supply byincreasing the discount interest rate.It is used to discourage businessinvestment, slow down theeconomy, and minimize inflation.
4 The Problem of Timing Good Timing Bad Timing Monetary policy must be timed carefullybecause if they are enacted at the wrongtime, they could actually intensify thebusiness cycle, rather than smooth it out.Good TimingGood timing will lower the peaksand make the troughs less deep.This will minimize inflation inthe peaks and the effects ofrecessions in the troughs.Bad TimingPoor data or policy lags cancause economists to not timemonetary policy properly.This can actually make the business cycle worse.
5 Policy Lags Inside Lags There are a couple of problems in the timing of macroeconomic policy:Inside lagsOutside lagsInside LagsInside lags - Delay in implementingmonetary policy.Inside lags occur for two reasons:It takes time to identify and recognize a problemOnce a problem has been recognized, it can take time to politically enact appropriate policyFiscal policy requires actions by Congress and the President and can take quite a while to enact.Monetary policy’s inside lag is streamlined because the FOMC meets 8 times a year and can make open market policy or discount rate changes almost immediately.
6 Outside lags Once a new policy is determined, it takes time to become effective.Outside lag - The time it takes formonetary policy to have an effect.For fiscal policy, the outside lag lasts as longas is required for the new governmentspending or tax policies to take effect.This can be a short amount of time.For example, tax rebates.Outside lags can be much longer for monetary policy since they primarily affect business investment plans.For example, firms may require months or even years to make large physical capital investment plans.Because of the political difficulties of implementing fiscal policy, we rely to a greater extent on the Fed to use monetary policy to soften the business cycle.
7 Predicting the Business Cycle The Federal Reserve must react to current trendsas well as anticipate changes in the economy.Monetary Policy and InflationGiven the timing problems of monetarypolicy, in some cases it may be wiser toallow the business cycle to correct itselfrather than run the risk of an ill-timedpolicy change (laissez-faire).On the other hand, if we expect arecession to last several years, thena more active policy is recommended.How Quickly Does the Economy Self-CorrectEconomists disagree, but they estimate that the USeconomy can self-correct in 2 to 6 years.
8 Approaches to Monetary Policy Laissez-faire economists who believe that the economy will self-adjust quickly will recommend against enacting new policies.Economists who believe that economies emerge slowly from recessions will usually recommend enacting fiscal and monetary policies to move the process along.The chart below shows how the federal government and the Federal Reserve can influence the nation’s economy.
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