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

5.  How might taxation reduce inflation?

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

7. 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

9. Keynes believed that income and outgo should balance each other out  equilibrium.

10. 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

11.  What happens to those workers after the govt is done with the project?

12. 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

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

14. 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

15.  It is like filling a bucket with water; you’ve got to know when to shut the water off. You don’t want this To turn into this

16. 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.

17. 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

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

19. 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

20.  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