8.4 Federal Reserve System Analyze the short- and long-term effects of fiscal and monetary policy on the United States economy.

Essential Questions: How does the Federal Reserve use monetary policy to ensure balance and stability in the US economy? What role does government spending play in maintaining a stable and solid economy? How does the federal government accrue revenue and determine its distribution?

Fiscal Policy Government spending Revenue Taxation Personal Income Tax Excise tax Regressive tax Progressive tax Proportional Tax Sales Tax

Fiscal Policy Fiscal policy determines how the government raises and spends money. Government needs to pay for its operations, programs, and payments to people for whom the government is responsible, such as retirees receiving Social Security.

Government Spending, Revenue, and Taxation Fiscal policy tries to create and stabilize economic growth through government spending and taxation, which creates most of the government’s revenue. A tax is an involuntary fee paid by individuals or businesses to the government. Modern capitalist taxation systems are intended to encourage the most efficient circulation of goods and services.

Types of Taxes The personal income tax is levied on the earned and unearned incomes of private individuals. An excise tax is levied on the production or consumption of a particular good, or use of a service, such as gasoline, tobacco, or alcohol. A sales tax taxes the purchase of goods and services by a percentage of the sale price. NC has a 6.75% sales tax.

How taxes are applied With a regressive tax, the more money you make, the smaller proportion paid in tax; sales tax is a regressive tax. A progressive tax increases with income. The income tax in the US is a progressive tax. A proportional tax, also called a flat tax, taxes all members of a group at the same rate.

Monetary Policy Federal Reserve System (FED) Loose (Easy) money policy Tight money policy Reserve requirement Discount Rate Interest rates

Federal Reserve System (Fed) The Fed sets monetary policy. Monetary policy is how much money is available for loans, investment, and spending. The Fed is the central bank of the USA. There is a central Board of Governors and 12 regional Federal Reserve Banks located in major cities throughout the nation. The Fed makes the determines how much money is in circulation.

The Fed’s Organization The Fed is run by its Board of Governors. Seven members appointed by the President of the United States. The Chairman of the Board is the most important position: presiding, directing, and testifying about Fed policy. She/He is appointed by the President. Monetary policy is made by the Federal Open-Market Committee.

Ben Bernanke is the current Chairman of the Federal Reserve.

Three Primary Functions of the Fed Regulate the private banking industry to make sure banks follow federal laws intended to promote safe and sound banking practices. Act as a banker’s bank, making loans to other banks and as a lender of last resort. Control of the supply of money i.e. Monetary Policy.

Organization of the Fed

Loose Money Policy A loose (easy) money supply means that getting money is relatively easy. More money is available for borrowing and investment. A loose economic money policy may help economic growth and employment.

Tight Money Policy When a restricted money supply makes borrowing money more difficult, money policy is considered to be “tight”. Tight money policy might be used to stop a rising inflation rate by discouraging investors from borrowing since they are less likely to borrow when interest rates are higher.

Inflation in America Inflation is the increasing of prices over time. This is why your parents and grandparents say things like “I remember when gas was …..!” Price changes, but for the most part value holds true. The dollar is worth about 10% what it was 40 years ago. This is why the price for items and salaries increase. Buying power has decreased.

Reserve Requirement Another tool of monetary policy is called reserve requirements. These are the percentages of deposits that banks must hold on deposit at the central bank. These funds are not available for lending by private banks. Increasing the reserve requirement tightens the money supply; lowering the reserve requirement tightens the money supply. Reserve requirements represent a cost to the banking system because banks cannot loan that money.

Interest Rate An interest rate is the price paid for the use of money for a period of time. When money is borrowed, the borrower pays interest to the lender for its use. The interest rate compensates for the lender’s economic risk.

Discount Rate The discount rate is the interest rate that an eligible bank is charged to borrow short-term funds directly from the Federal Reserve. The discount rate is also known as the “base rate”. To make a profit, banks must charge borrowers higher interest than the discount rate. Increasing the discount rate tightens the availability of money; lowering the discount rate loosens the availability of money.