Fiscal and Monetary Policy

Ch. 24

The Government and the Economy Regulating the economy We want slow growth If the economy is not doing good we can fall into a

recession (right now) and people can lose their jobs If the economy is growing too fast we can have

rapid inflation; where prices rise faster than wages Both are bad – Two ways to make sure our

economy is growing slowly Fiscal and Monetary Policy

An economic model is based on which of the following?1. Statistics

2. Facts

3. Distortions

4. Assumptions

Fiscal and Monetary Policies Fiscal Policy – Government

Government spending = Tax Revenue (G=T) = Neutral Government spending > Tax Revenue (G>T) = Budget

Deficit Higher G spending, lower taxes, or combination of both

Government spending < Tax Revenue (G<T) = Budget Surplus Lower G spending, higher taxes, or combination of both

Slow to work and situation changes Monetary Policy – Federal Reserve

Controlling the money supply Availability of money Cost of money (interest rates)

Mortgage payments are classified under which cost category?1. Marginal cost

2. Fixed cost

3. Variable cost

4. Total cost

The Federal Reserve (FED) Independent Agency: part of the government

but unattached to Congress & the President Allows them to make economic decisions free

from political pressure Roles of the FED

1. Regulates foreign banks that do business in the U.S.

2. Our Government’s bank Holds government’s money Buys and Sells Bonds for Government Issues our currency

3. Conducts Monetary policy

FED Headquarters in Washington D.C

What contributes the most to the US GDP?1. Goods

2. Social Studies books

3. Services

4. Utilities

The Federal Reserve (FED) cont. Board of Governors (7 member board)

Chairman – Ben Bernake Alan Greenspan was Chairman from 1987 to

2006 Advisory Council (12 members – 1 from each

district) Federal Open Market Committee (FOMC) –

major policy making group 12 Federal Reserve Banks & Branch banks

FED Diagram

Federal Reserve Districts

Assets in Each Reserve Bank

Chairmen of the FED

Ben Bernanke Alan Greenspan

The demand for the following items is likely to inelastic?1. A car

2. Electricity

3. A fur coat

4. A computer

Fractional Reserve Banking The tools the FED has to create money

Discount rate – prime rate which banks borrow money from the FED

Reserve Requirements – Percentage of deposits that banks must hold

Open Market Operations – buying and selling of government bonds

Federal Funds Rate – interest rate that banks lend to other banks usually overnight

Federal Funds Rate Example Suppose a bank issues a loan which takes

money out of the bank and lowers its reserves. If it falls below the reserve requirement, it must borrow money from another bank that has a surplus of funds. The rate the other banks charge is the federal funds rate.

Which of the following pairs is not an example of substitutes? 1. Margarine for butter

2. Pens for pencils

3. Coffee for tea

4. Dollar coins for dollar bills

Monetary Policy Quicker response than fiscal policy Regulates the amount of money in circulation Tight Money Policy

Goal is to stall growth to stop inflation Taking money out of circulation Can lead to a recession Raising interest rates Raising the reserve requirements Selling bonds

Monetary Policy cont. Loose Money Policy

Goal is to start growth of the economy to combat a recession

Increasing the money supply Can lead to inflation Lowering of interest rates Lowing reserve requirements Buying bonds

Which of the following pairs Which of the following pairs is is notnot an example of an example of compliments?compliments?1. Computers and software

2. Tennis rackets and tennis balls

3. Cars and hydroelectricity

4. Lamps and light bulbs

Fiscal Policy Government (politicians) use taxing and spending to regulate the

economy Tools:

Tax: can be raised or lowered Spending: can be increased or decreased. Ex. Cutting back on

public works projects Tight Fiscal Policy

Combat inflation Raise taxes Cut spending Take money out of economy – slow economy

Loose Fiscal Policy Combat a decline Cut taxes Increase spending Put money into Economy – grow economy

What is the rough What is the rough percentage of American percentage of American workers who belong to a workers who belong to a union?union?1. 92%

2. 38%

3. 14%

4. 77%

Tight Monetary Policy

Federal Funds rate goes up

The FED sells Treasury securities, taking money out of the economy

Short term interest rates go up (% ^) because banks have less money to lend

Consumers and Businesses will borrow less money

Consumer and Business spending will decrease because they have less money

Economic growth and employment may decrease in the short-term