Economics Chapter 13: FISCAL AND MONETARY POLICY

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1 Economics Chapter 13: FISCAL AND MONETARY POLICY SECTION 1 Fiscal Policy Two Types of Fiscal Policy Fiscal policy deals with the government makes in spending or taxation to achieve particular economic. o fiscal policy is an increase in government spending or a reduction in taxes. o fiscal policy is a decrease in government spending or an increase in taxes. Expansionary Fiscal Policy and the Problem of Unemployment Government can use expansionary fiscal policy to decrease the rate. This is how it works: o A high unemployment rate is the result of people not enough money in the economy. o If the government spending or taxes, or both, consumers will have money to spend. o An increase in government spending will mean more spending in the economy. o o As a result of the increase in total spending, business firms will more goods. When business firms sell more goods, they have to more workers to produce the additional goods. The unemployment rate goes because more people are working. Contractionary Fiscal Policy and the Problem of Inflation Inflation is the result of spending in the economy compared with the quantity of goods and services for purchase. The government can inflation by reducing the amount that it spends. As a result of the decrease in total spending, firms initially sell goods. To reduce unwanted, firms lower. Fiscal Policy and Taxes - income is the part of income that is left over after taxes are paid. If the government taxes, more money is available from earnings and total spending. This leads to increased sales and hiring, the unemployment rate. If the government raises taxes, the occurs. After-tax income is reduced, decreasing spending and causing unemployment to increase. People are willing to work when taxes are. If taxes were 100 percent of earnings, there would be no incentive to work. Lower tax rates do necessarily result in lower tax revenues for the government. Lower tax rates will likely give to work more, and may result in increased, all of which provides tax for the government.

2 Section 1 - Fiscal Policy (Applying the Principles) 1. If government increases, reduces, or both, government is said to be implementing expansionary fiscal policy. 2. If government decreases, raises, or both, government is said to be implementing contractionary fiscal policy. 3. According to some economists, government can use expansionary fiscal policy to reduce the rate. 4. According to some economists, government can use contractionary fiscal policy to reduce. 5. Because high unemployment is most likely to occur during the phase of the business cycle, government might consider using fiscal policy at this time. 6. Because high inflation is most likely to occur during the phase of the business cycle, government might consider using fiscal policy at this time. Use the following key to label each of the government actions in questions as expansionary or contractionary fiscal policy. E = expansionary fiscal policy C = contractionary fiscal policy 11. The government cuts income tax rates. 12. The government eliminates most tax deductions and tax credits. 13. The government increases spending for education. 14. The government raises the Social Security tax rate. 15. The government cuts funding to the NASA program. For each of the economic problems described in questions 16-20, determine the type of fiscal policy that might be used to solve the problem. Then indicate whether taxes and government spending should be increased or decreased to implement the fiscal policy. 16. The economy is growing at a rapid pace and the inflation rate has hit 9%. 17. The unemployment rate hit 11% last month.

3 18. Corporations are recording record profits and the incomes of consumers are rising rapidly; economists worry that the economy may be growing too rapidly. 19. The stock market has been declining for several weeks, and surveys show that consumer confidence is at a four-year low. Economists worry that the economy may be slowing. 20. The economy has been lagging; real GDP reports have been negative for three consecutive quarters.

4 The Fiscal Ship: A Fiscal Policy Game Your Task: The Fiscal Ship challenges you to put the federal budget on a sustainable course. Measured as a share of gross domestic product, the federal debt is higher than at any time since the end of World War II and projected to climb to unprecedented levels. America is looking at a permanent, growing mismatch between revenues and spending, and policymakers are faced with difficult decisions about how to reconcile important government priorities including retirement and health benefits promised to the growing number of old folks with the tax revenues that the current tax code will yield. Today s tax code won t yield enough revenue to pay for basic services of government plus the retirement and health benefits promised to the growing number of old folks. So your mission is to pick from a menu of tax and spending options to reduce the debt from projected levels over the next 25 years. Small changes to spending and taxes won t suffice. The choices are difficult, but the goal is achievable. But budget decisions aren t only about fiscal sustainability. They also shape the kind of country we live in. To win the game, you need to find a combination of policies that match your values and priorities AND set the budget on a sustainable course. THE LINK IS POSTED ON MY WEBSITE. ( ) 21. How is fiscal sustainability defined in the game? 22. What 3 options did you choose for your governing goals? 23. Which tax and spending policies did you choose? 24. How successful were you? 25. Now play the game again using a different strategy. What did you change? Were you able to improve?

5 SECTION 2 Monetary Policy Tw o Types of Monetary Policy Monetary policy is defined as changes the Fed makes in the money supply. o An expansionary monetary policy is an in the money supply. o A contractionary monetary policy is a in the money supply. Expansionary Monetary Policy and the Problem of Unemployment Many economists believe that expansionary monetary policy the unemployment rate by the following means: o The Fed the money supply. o This in turn leads to increased. o Increased spending results in increased and increased. Contractionary Monetary Policy and the Problem of Inflation Many economists believe that contractionary monetary policy works to inflation in the following manner: o The Fed the money supply. o A smaller money supply results in total spending. o Firms inventories because they sell fewer products. o Firms reduce to lower their inventories. *************************************************************************************** Section 2 - Monetary Policy (Applying the Principles) 26. If the Fed increases the, it is said to be implementing monetary policy. 27. If the Fed decreases the, it is said to be implementing monetary policy. 28. According to many economists, the Fed should use expansionary monetary policy to reduce the. 29. According to many economists, the Fed should use contractionary monetary policy to reduce. 30. The Fed is most likely to use expansionary monetary policy during the phase of the business cycle. 31. The Fed is most likely to use contractionary monetary policy during the phase of the business cycle.

6 Recall that the Fed has three tools it can use to influence the money supply. Complete the following table by explaining how the Fed uses each tool to reduce unemployment or inflation. Fed Tool Reserve Requirement Open Market Operations Discount Rate To reduce the unemployment rate... the reserve requirement Conduct open market the discount rate To reduce inflation... the reserve requirement Conduct open market the discount rate

7 Chair the Fed: A Monetary Policy Game Your Task: The President of the United States has nominated you and the U.S. Senate has confirmed you to serve as the Chair of the Federal Reserve. Your job is to set monetary policy to achieve full employment and low price inflation. Your term will last 4 years (16 quarters). As you complete the game, answer the questions below based on your decisions, the frequently asked questions on the site, and additional research Before you begin, explain the Federal Funds Rate (you will need to research beyond the game for this information). 39. What are the two goals of federal monetary policy? 40. Why would it be almost impossible to reach zero unemployment? 41. What is the natural or normal unemployment rate? Compare this to the actual unemployment rate in the United States (you will need to research this separately from the game). 42. The game suggests that the Fed should target inflation at 2%. Why? 43. In reality, the Fed Chair does not set monetary policy. Who has this responsibility in the United States? 44. How does a change in the fed funds rate affect U.S. citizens?

8 SECTION 3 Stagflation: The Two Problems Appear Together Rising Unemployment and Inflation (at the Same Time) For many years, economists believed that the economy would experience either inflation or unemployment, but not both at the same time. They believed that unemployment and inflation moved in directions. In the s, inflation and unemployment began to move in the same direction. They both began to increase. The occurrence of inflation and high unemployment at the same time is called. What Causes Stagflation? Stagflation may be a result of stop-and-go, on-and-off monetary policy, or an monetary policy. When the Fed the money supply, prices rise. begins to set in, just as the Fed decides to the money supply. This causes output to decrease and unemployment to. Another cause of stagflation might be a market in aggregate supply, such as that caused by a storm or a war.