Fiscal and Monetary Policy

Transcription

1 Fiscal and Monetary Policy Chapter 13 Part 4 of the Final Exam Review should be put in the basket on the projector cart at the beginning of class. The answer key for Part 3 is posted around the room. When you have work time later in class, you may check your answers. No taking pictures! Today in class we will complete Chapter 13 and then you will have the rest of the period to complete your Global Economy and Stock Projects.

2 Two Types of Fiscal Policy SECTION 1 Fiscal Policy Fiscal policy deals with changes the government makes in spending or taxation to achieve particular economic goals. Expansionary fiscal policy is an increase in government spending or a reduction in taxes. Contractionary fiscal policy is a decrease in government spending or an increase in taxes.

3 Two Types of Fiscal Policy

4 Expansionary Fiscal Policy and the Problem of Unemployment Government can use expansionary fiscal policy to decrease the unemployment rate. This is how it works: A high unemployment rate is the result of people not spending enough money in the economy. If the government increases spending or reduces taxes, or both, consumers will have more money to spend. An increase in government spending will mean more spending in the economy. As a result of the increase in total spending, business firms will sell more goods. When business firms sell more goods, they have to hire more workers to produce the additional goods. The unemployment rate goes down because more people are working.

5 Contractionary Fiscal Policy and the Problem of Inflation Inflation is the result of too much spending in the economy compared with the quantity of goods and services available for purchase. The government can slow inflation by reducing the amount that it spends. As a result of the decrease in total spending, firms initially sell fewer goods. To reduce unwanted inventory, firms lower prices.

6 Fiscal Policy and Taxes After-tax income is the part of income that is left over after taxes are paid. If the government lowers taxes, more money is available from earnings and total spending increases. This leads to increased sales and hiring, reducing the unemployment rate. If the government raises taxes, the opposite occurs. After-tax income is reduced, decreasing spending and causing unemployment to increase. People are more willing to work when taxes are lower. If taxes were 100 percent of earnings, there would be no incentive to work. Lower tax rates do not necessarily result in lower tax revenues for the government. Lower tax rates will likely give incentive to work more, and may result in increased spending, all of which provides tax revenue for the government.

7 SECTION 2 Monetary Policy Two Types of Monetary Policy Monetary policy is defined as changes the Fed makes in the money supply. An expansionary monetary policy is an increase in the money supply. A contractionary monetary policy is a decrease in the money supply.

8 Expansionary Monetary Policy and the Problem of Unemployment Many economists believe that expansionary monetary policy lowers the unemployment rate by the following means: The Fed increases the money supply. This in turn leads to increased spending. Increased spending results in increased sales and increased hiring.

9 Contractionary Monetary Policy and the Problem of Inflation Many economists believe that contractionary monetary policy works to reduce inflation in the following manner: The Fed decreases the money supply. A smaller money supply results in lower total spending. Firms inventories increase because they sell fewer products. Firms reduce prices to lower their inventories.

10 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 high inflation or high unemployment, but not both at the same time. They believed that unemployment and inflation moved in opposite directions. In the 1970s, 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 stagflation.

11 What Causes Stagflation? Stagflation may be a result of stop-and-go, on-and-off monetary policy, or an erratic monetary policy. When the Fed increases the money supply, prices rise. Inflation begins to set in, just as the Fed decides to reduce the money supply. This causes output to decrease and unemployment to increase. Another cause of stagflation might be a market decrease in aggregate supply, such as that caused by a storm or a war.