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CAS PO 111 (17)
Chapter 17

Chapter 17 Economic Policy.pdf

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Boston University
Political Science
CAS PO 111
Graham Wilson

Chapter 17: Economic Policy Tuesday, December 3, 2013 4:02 PM I. Theories of Economics Policy A. Laissez-Faire Economics (Hayek) • Efficient market hypothesis: Financial markets are informationallyefficient-theyquickly absorb all relevant informationabout securities into their prices ○ Securities are fair priced and consumers cannot beat the market B. Keynesian Theory (Keynes) • Economic depression: High unemployment and business failures; a severe, long-lasting downturn in a business cycle • Inflation: Price increases linked to a decrease in the value of currency • Stagflation: Joint occurrence of slow growth, unemploymentand inflation • Business cycles: Expansions and contractionsof business activity, first by inflation,then by unemployment ○ “Stem from imbalances between aggregate demand and productive capacity”  Aggregate demand: Total income that consumers, businesses, and gov’t wish to spend on goods and services  Productive capacity: Total value of goods and services that can be produced when the economy works at full capacity □ Gross Domestic Product (GDP): Total value of the goods and services produced by a country during the year ○ When demand exceeds productive capacity, people are willing to pay more, which leads to inflation ○ When productive capacity exceeds demand, businesses cut back, which causes unemployment • Keynesian Theory: Gov’t can stabilize the economy by controlling the level of aggregate demand with fiscal and monetary policies ○ Fiscal policies: Gov’t spending and taxing  When demand is low, gov’t should spend more and hire people or cut back on taxes to give people more money to spend  When demand is too high, gov’t should raise tax ○ Monetary policies: Control and changes in the supply of money  Determined by the Federal Reserve Board  Increasing the money in circulation raises aggregate demand and increase price inflation  Decreasing the money in circulation lowers aggregate demand and relieve the price inflation ○ Deficit financing: Spendingbeyond gov’t revenue to combat economic slump  Increase money circulation to stimulate aggregate demand  Deficits can be paid off with the surplus after the economy recovers ○ Government has accepted the responsibility of the economy C. Monetary Policy • Keynesian theory requires gov’t to start and end policies according to the economy ○ Easier to cut taxes then raise and easier to raise spendingthan lower • Monetarists: Gov’t can control the economy mainly by controlling the supply of money ○ Long range policies of small changes rather than frequentmanipulation of policies • Federal Reserve Board: System of banks that acts as the central bank of the US and control major monetary policies control major monetary policies ○ Control inflation ○ Maintain maximum employment ○ Insuring moderate interest rates ○ Independentfrom the President and Congress ○ Dodd-Frank Act: Gave Feds power to regulate complex financial firms ○ Controls the supply of money which affects inflation  Sell and buy gov’t securities on open market □ Sell: lowers circulation and raise interest rate □ Buy: increase circulation and lower interest rate  Sets the federal funds rate (what banks charge each other for loans), discount rate (what the Fed charge banks for borrowing) and the reserve requirement (amount of money each bank must keep in the Fed deposit) • Interest rates should be raised to discourage borrowing when the economy is growing too fast to avoid inflation and lowered to encourage borrowing when the economy is sluggish ○ Feds usually raise interest rates and not lower which causes unemployment ○ Creditors fear inflation because it reduces the value of their wealth and debtor favor inflation because it is easier to pay off loans D. Supply-Side Economics (Reagan) • Supply-Side Economics: Aimed at increasing the supply of goods instead of decreasing demand; consists of tax cuts for investors and less regulation of businesses ○ Generate more gov’t revenue which makes spendingcuts unnecessary • Reaganomics: Tax cuts, deregulation,cuts in programs and increase spending on defense ○ Cutting tax actually generated less tax revenue and defense spendingcaused a larger national deficit II. Public Policy and the Budget ○ Congress is the first branch of the government ○ The president prepares the budget and the Congress approves  The president has emerged as the leader in the budget process □ The Congress usually challenges the president □ Before 1921, Congress prepared the budget  Decentralizedprocess of authorizingappropriations □ Soon after WWI, Congress realized that budgetingneeded to be centralized  Budget Accounting Act of 1921: Gave the president the responsibilityof budgeting ◊ Established a Bureau of the Budget to prepare the president's budget (Now the Office of Management) A. The Nature of the Budget ○ The Budget of the United States Government: Annual financial plan that the president is required to submit to Congress at the start of each year. (It applies to the next fiscal year)  Fiscal year is from October 1st to September 30th ○ Budget auth
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