Chapter 16: Government and the Economy

Why Is Government Involved in the Economy? We continue to debate the proper role of the government in dealing with the economy. –At times, a less active government is seen as more important. –However, a more active government may seem necessary (e.g., airline industry bailout).

The Role of Government Managing the economy Protecting the welfare and property of individuals Regulating competition Providing public goods

Should Government Be Involved in the Economy? What are the main arguments in the debate over the proper role of the government in the economy?

Economic Theory Laissez-faire capitalism Keynesians Monetarists

Classical Economics Adam Smith and The Wealth of Nations The government that governs least is the government that governs best. Government should not compete with the private sector.

Keynesian Economics The Depression was the product of declining demand. Government could use deficit spending to fund programs to stimulate demand. Government should reduce spending once the economy recovers.

What Are the Goals of Economic Policy? Promote a strong and stable economy Promote business development Promote international trade Regulate industrial relations Protect the environment Protect consumers

What Are the Tools of Economic Policy Monetary policy –Discount rate –Reserve requirement –Open market –Federal funds rate Fiscal policy –Taxation –Spending and budgeting Regulation and antitrust Subsidies and contracts

Monetary and Fiscal Policy Taxes Fiscal policy –Budgeting and spending using subsidies and contracts –Deficit spending Monetary policy –Use of credit and interest to control demand of money and consumption

Monetary Policy Monetary policy is exercised by the Federal Reserve Board. Monthly adjustments in the interest rate are designed to stabilize the inflation rate and promote a stable economy.

The Federal Reserve Board The Federal Reserve System was created in 1913 –Federal Reserve Bank –Federal Reserve Board Chairman (four-year term) Six governors (fourteen-year terms)

The Federal Reserve Board Monetary Strategies Discount rate –The setting of interest on loans to member banks Open market operations –The buying and selling of government securities Reserve requirements –The amount of liquid assets and ready cash that banks are required to hold to meet depositors’ demands

The Federal Government Other Strategies Federal Funds Rate involves the interest rate on loans between banks. FDIC FSLIC

Fiscal Policy Fiscal policy is generally exercised by the president and Congress. Taxing and spending levels are adjusted to affect the economy.

Taxes Taxes are used to redistribute money from one sector of society to another. Taxes can also be used to encourage or discourage certain types of behavior.

Taxation Tariffs Sixteenth Amendment (1913) –Authorizes Congress to tax incomes Progressive taxation –Income tax Regressive taxation –Sales tax –Social Security

Regulation Administrative regulations are rules made by regulatory agencies and commissions to control specific areas. –OSHA regulates workplace safety; noncompliance may result in fines or other penalties.

Subsidies Subsidies are government grants of cash or other valuable commodities to promote certain activities. –Crop subsidies used to promote stable crop levels

Contracts Contracts are agreements with individuals or firms in the private sector to purchase goods or services. –Military contracts used to develop defense systems

The Politics of Economic Policy A healthy economy is the goal of both parties. However, differences exist as how best to achieve this objective in terms of political parties and interest groups.