1. Topic 6
Using Monetary and Fiscal Policy to Fight Unemployment and Inflation

2. Inflation Cause: too much economic activity Fix: slow down spending
There are too few factors or production to support the demand for production, prices rise
Fix: slow down spending
Contractionary fiscal and monetary policy (decrease G, increase Tx, increase RRR, sell bonds, increase federal funds rate)

3. Unemployment Cause: not enough economic activity
The economy’s factors of production could support more output
Fix: increase economic output
Expansionary monetary and fiscal policy (increase G, decrease Tx, lower RRR, buy bonds, lower federal funds rate)

4. Some schools of thought
Supply side economics – tax breaks and incentives for producers are the most effective way to stimulate the economy
Demand side economics – tax breaks and incentives for consumers, plus government spending, is the best way to stimulate the economy

5. Trade off – The Philips Curve
Graph the Philips Curve – In class
Vertical axis for inflation, horizontal axis for unemployment
How to incorporate Natural Rate of Unemployment?
How to incorporate Inflationary Expectations?
As the labor market becomes tighter, what happens to prices?

6. Changes in Philips Curve
Changes in the Natural Rate of Unemployment?
Monster.com? Minimum wage? Culture of changing jobs?
Changes in inflationary expectations?
People expect higher or lower inflation
Changes in worker bargaining power?
Ability to move production over seas

7. Current Unemployment & Inflation
Unemployment, as of April 1st, is 8.5%
Inflation is down, currently at about 0%
Inflation, ignoring food and energy costs is down slightly to 1.8% (it was 2.3% in 2007 and 2008)
See graphs on next slides (from BLS and inflationdata.com)

11. So, where are we on the Philips Curve? What policies help?

12. Monetary Policy Open Market Operations (to alter the interest rate)
Required Reserve Ratio (RRR)
Federal Funds Rate

13. 12/08 Rates for US Treasury Bonds
COUPON MATURITY YEILD 3-Month /26/ Month /25/ Month /17/ Year /31/ Year /15/ Year /31/ Year /15/ Year /15/

14. US Treasury Bill Rate

15. Reserve Requirements
Requirement Type of liability Percentage of liabilities Effective date Net transaction accounts $0 to $10.3M 0% $10.3M to $44.4M 3% > $44.4M 10%

16. Federal Funds Rate

18. Fiscal Policy Government spending Taxes
Without much room to play with monetary policy, the government is relying heavily on fiscal policy

19. Projected Deficit (Wash Post)

20. Keynesian Economics
Unemployment is caused by insufficient aggregate demand for goods and services
Expansionary monetary and fiscal policy increase aggregate demand, thereby decreasing unemployment

21. Alternatives to Keynes
Unemployment is caused by bad policies or an inflexible economy
Economies must be able to adjust to government or market induced shocks to employment
Along these lines are current government policies to encourage bank lending and “fix” the banking system
Structure of tax system and quality of government spending are important
Make it easier for producers and consumers to respond to shocks—transparency, incentives, etc.
In recession, govt spending might help speed up turn around, but will not be long term solution