1. Stabilizing the National Economy
Chapter 17
Stabilizing the National Economy

2. Section 2: The Fiscal Policy Approach to Stabilization
Fiscal Policy- Federal Government’s use of taxation and spending policies to affect overall business activity

3. The Circular Flow of Income
Income flows from businesses to households as wages, rent, interest, and profits. Income flows from households to businesses as payments for consumer goods and services
Not all income follows the circular flow. Some is removed from the cycle through taxes and savings (Leakage). Business investment and government spending offset leakages (Injections).

4. The Circular Flow of Income
Purchases
Wages, Transfer Payments, Interest
Purchases
Taxes
Taxes
Govt borrows
Savings
Loans for investment
Income

5. Two Major Schools of Thought on Fiscal Policy
Demand-Side (Keynesian Economics)
Supply-side Economics (Jean-Baptiste Say; also referred to as Reaganomics)

6. Keynesian Economics
John Maynard Keynes developed fiscal policy theories during the Great Depression
Said that forces of aggregate supply and demand acted too slowly during a serious recession government needed to inject $ into economy into stimulate aggregate demand
His policies are known as Demand-Side Economics
Democrats tend to follow Demand-Side Economics

7. Illustration of Demand-Side Economics
Govt. job programs to reduce unemployment and stimulate the economy
Govt. hires the unemployed to work on public-works projects (roads, bridges, power plants, etc.) borrows money to pay them workers go out and spend money demand for goods increases businesses hire back their laid off workers aggregate demand expands enter expansion period Govt. pays off its loan by charging a fee to use the public works (ex- tolls) that the workers completed

8. Supply-Side Economics
Govt. cuts federal taxes, especially for big businesses give businesses tax credits on investment allowing them to purchase new equipment and hire more workers more workers means more spending new businesses open to meet the demand economic expansion

9. Examples of Supply-Side Economics
Reagonomics- Trickle- Down Theory of the 1980’s
President Bush’s Jobs and Growth Tax Act of 2003

10. Problems with Fiscal Policy
Politicians overuse them they are only supposed to be used to get us out of a recession
Republicans get elected on promises of tax cuts, so they hesitate to raise taxes when the economy expands too quickly
Democrats get elected on promises of increased spending on jobs programs and social welfare programs, so they hesitate to decrease the funding when the economy is expanding too quickly

11. Section 3: Monetarism and the Economy
Monetarism is the theory that deals with the relationship between the amount of money the Fed places in circulation and the level of activity in the economy
Milton Friedman is a leading supporter of monetarism
Monetarists argue that the Fed should increase the money supply at a set rate every year.

12. Government Policy according to Monetarists
Monetarists oppose fiscal policy because they believe that the government does more harm than good when they try to manipulate the economy
Against budget deficits and deficit spending to stimulate the economy govt. should balance their budget, erase all debts, and stop competing with businesses to borrow $ from banks
Support the monetary rule, allowing the money supply to grow steadily at a rate of 3-5% a year controlled expansion would avoid rapid inflation and high unemployment

13. The Fed used monetary policy in the 1980’s and it worked, but then 9/11 happened an everything became unpredictable

14. Monetarist’s Criticism of Fiscal Policy
No one single government body is responsible for fiscal policy
President, OMB, Sec’y of Treasury, and Council of Economic Advisors recommend changes in fiscal policy Congress, w/ the aid of many committees enacts fiscal policy politics and loyalties get in the way changes are made to suit special interests recommended policy and actual policy differ greatly

15. Even if the recommendations are followed, there are time lags between the start of the budget process and when the fiscal policy actually goes into effect too slow to stop the economic crisis