Unit 2: Unit 2: The Government, The Government, Banking and the Banking and the EconomyEconomy

Who in government has the responsibility to respond when the economy is in trouble?

The President?Congress?The Fed?

Keeping watch over…

THE BUSINESS CYCLE

Business cycle

The Business Cycle

Contraction vs. Expansion Peak vs. Trough Recession vs. Depression

Recession Characteristics…2 Quarters declining GNP6-18 monthsunemployment rates risestable (or declining) prices

Why & How does this happen?

Variables that determine the Business Cycle… WHY ???

Business InvestmentsInterest rates & CreditConsumer expectationsExternal shocks

Business Investments

Investment spending increases GDP and maintains expansion - growth

Business cuts leads to a decline in aggregate (total) demand & GDP slows/contracts- recession

Business cuts causes a reduction in output & income in other sectors & GDP slows/contracts- recession

Interest Rates & Credit

Business and consumers’ spending are influenced by rates and availability of creditAs rates climb, or loans become hard to get, spending and investment dries up, as does job growth

(CONTRACTION – RECESSION)

This is what happened throughout 2009 after many big banks collapsed!

Consumer expectations

Expectations breed fear or hope…Consumers expect layoffs – stop spending!Consumers expect raises – spend more!

Consumer expectations become self-fulfilling prophesies

External shocksSome factor indirectly has an impact on the economy…

Drought, war, oil embargo, etc. can affect aggregate supply

As supply changes, so does production and price, thus impacting GDP (1970s OPEC Oil crisis)

Who in government has the responsibility to respond when the economy is in trouble?

The President?Congress?The Fed?

Monetary Policy

Controlled by the Federal ReserveFederal Reserve The Bank for Banks Board of Governors, Regional Banks Janet Yellen

Goal: To expand or contract the amount of Goal: To expand or contract the amount of money in supply so as to control spending and money in supply so as to control spending and inflation and manage the business cycleinflation and manage the business cycle

Three Methods Interest rates Open Market Operations Reserve requirement

2009

http://www.pbs.org/newshour/making-sense/how-candid-should-janet-yellen-be-watching-emerging-markets-overreact-to-fed-transparency/

Monetary PolicyThe Federal Reserve’s attempt to control the business cycle

How… track the economic indicators, and control the amount of money in supply

how does the FED know when these events are taking place??

Economic Indicators

Economic Indicators Unemployment

Types: Frictional (always exists)seasonal structural (changing society) cyclical (accd. to business cycle)

InflationChanges to the Consumer Price Index

Economic GrowthGross National / Domestic Product

Define the three methods of Monetary Policy… Open Market Operations Discount rate Reserve requirement

Interest Rates (Discount Rate)

The rate the Fed charges banks to borrow money

Lower the rate – expansionary Raise the rate - contractionary

Mortgage Calculator

Interest Rates

Open Market Operations

The Fed’s buying and selling of US securities (bonds) to add or subtract from the reserves of the nation’s banking system

Purchase of bonds – expansionary Sale of bonds - contactionary

Reserve Requirements

The fraction of money (based on total money) banks are required to keep on reserve

The amount of money banks ‘have on hand’ – or can’t loan out to borrowers

Set as a % Lower the percentage – expansionary Raise the percentage – contractionary

Practice scenarios…

7% Inflation4% Unemployment3% GNP Growth Rate

10% Unemployment-2% GNP Growth 2 %inflation

6 % Inflation9 % Unemployment

FISCAL POLICY

Other alternatives…

Who else is responsible?

Fiscal Policy

Congress/President adjust federal taxes and federal spending

Meant to control aggregate demand and sometimes aggregate supplyLike monetary policy, it can be expansionary

or contractionary Intended to monitor and adjust the

Business cycle

Circular flow…includes the government…

When and how does the Government enact an expansionary fiscal policy? When? During a Recession or …

high unemployment, low business and consumer spending, declining GNP

How? Government raises aggregate demand by becoming a

major consumer (spending) Government cuts taxes, thus raising aggregate demand, or

allowing people more disposable income Problems/Controversy?

National debt/deficit Where is the money going?

When and how does the Government enact an contractionary fiscal policy?

When? Economy is growing quickly – Inflation results How?

Government lowers aggregate demand by cutting government spending

Government raises taxes, thus lowering aggregate demand, or decreasing the amount of personal disposable income

Problems/Controversy? What programs should be cut by the government?

Examining trends

U.S. federal spending as a percentage of gross national product from 1790 to 1990.