Fiscal and Monetary Policy Unit 4 Macroeconomics Fiscal and Monetary Policy

Fiscal Policy Fiscal Policy= Changes in the expenditures or tax revenues of the federal government, undertaken to promote full employment, price stability and reasonable rates of economic growth. Government Taxation: Funds raised through taxing and borrowing to pay for government expenditures. The amount of government taxation depends on a number of factors including political ideology, the state of the economy and the political climate.

Fiscal Policy Government expenditures (spending): Goods and services provided by government and paid for by taxing and borrowing. Federal government expenditures include national defense and a system of justice. State and local government expenditures include police, roads and public education. The amount of government spending depends on a number of factors including political ideology (ex: Conservative, Liberal, etc.), the state of the economy and the political climate.

Fiscal Policy Expansionary Policy- when the economy is in a recession or trough, the government might lower taxes and increase spending to help boost the economy. The idea is to get people to spend more money so that businesses will hire more people. Contractionary Policy- when the economy continues to peak and prices are high (inflation) for a long period of time, the government might raise taxes and lower spending to try and slow down the economy. The idea is to get people to spend less money so consumer demand will go down and prices will fall.

Fiscal Policy Contractionary Fiscal Policy Expansionary Fiscal Policy

Monetary Policy The central bank of the United States is the Federal Reserve (the “Fed). The Federal Reserve System was created in 1914. Over time the Fed has taken on more responsibilities in helping to shape the economy. Its main function is controlling the money supply through monetary policy.

Monetary Policy The Federal Reserve System divides the country into 12 districts, each with its own Federal Reserve bank. The Board of Governors, which is made up of seven members appointed by the President and confirmed by the Senate to 14-year terms, directs the nation's monetary policy and the overall activities of the Fed. The Chairman of this board serves a four year term (not term limited). The Federal Open Market Committee (FOMC) is the official policymaking body; it is made up of the members of the Board of Governors and five of the district bank presidents.

Monetary Policy

Monetary Policy F.O.M.C. makes key monetary policy decisions on interest rates

Monetary Policy The goal of the Fed is to make changes in the supply of money and the availability of credit initiated by a nation's central bank to promote price stability, full employment and reasonable rates of economic growth. Full employment in the U.S.= 5% unemployment Stable rate of inflation= no more than 2% per year

Monetary Policy Open Market Operations: The buying and selling of government bonds (securities) by the Federal Reserve to control bank reserves and the money supply. To increase the availability of money the Fed buys government bonds (securities). To tighten the availability of money the Fed sells bonds (securities).

Monetary Policy Discount Rate: The interest rate the Federal Reserve charges commercial banks for loans. A change in the discount rate can either inhibit or encourage financial institutions’ lending and investment activities by making it more or less expensive for them to obtain funds.

Monetary Policy Federal Funds rate: The interest rate at which a depository institution (bank) lends immediately available funds to another depository institution overnight.

Monetary Policy Reserve Requirement Ratio: The fraction of banks' deposits that they are required by law to keep on hand or with the Federal Reserve. Lower reserve requirements mean banks can loan out a higher percentage of deposits, higher reserve requirements mean banks must keep a higher percentage of deposits in the vault and cannot loan out as much money.

Reserve Ratio= Fractional Banking Start with $100, 10% reserve ratio Reserve Ratio= Fractional Banking You deposit $100 into your savings account- bank keeps $10, and loans out $90 And the process of depositing and lending money keeps going and going…

Pros and Cons of Expansionary Fiscal and Monetary Policy Expansionary Fiscal Policy: PRO= helps the economy grow, cuts unemployment CON= can lead to higher deficits, add to the total debt Expansionary Monetary Policy (aka “easy money”): PRO= lower interest rates makes money cheaper to borrow, people spend more money, unemployment goes down CON= too big of an increase in the money supply can lead to high inflation

Unit 4 Essay: Fiscal vs. Monetary Policy Part 1: What might the government do to boost or slow down the economy? Part 2: What might the Fed do to boost or slow down the economy? Part 3: What are the negatives of too much expansionary policy?

Sources: http://internet.savannah.chatham.k12.ga.us/schools/jhs/staff/Campbel l%201/Shared%20Documents/macro.pdf http://myeconomicsclass.wikispaces.com/HOME