1 Lesson 9.1 The Federal Budget and Fiscal Policy
2 The Federal Budget and Fiscal PolicyFederal Budget Basics: Step 1: Agencies Submit Spending Proposals Step 2: Executive Branch Draws Up a Budget Step 3: Congress Debates Congressional staff members receive massive copies of the proposed budget. Step 4: Back to the White House
3 The basic steps in the establishment of a federal budget are shown here. Why do you think compromise is such an important part of the budget process?
4 How Fiscal Policy Decisions Impact the EconomyExpansionary Fiscal Policy decreasing taxes and/or increasing government expenditures OUTCOME: A decrease in taxes means that households have more disposable income to spend. Higher disposable income increases consumption which increases GDP. Contractionary Fiscal Policy increasing taxes and/or decreasing government expenditures OUTCOME: Due to an increase in taxes, households have less disposable income to spend. Lower disposable income decreases consumption.
5 To Contract, government buys fewer goods and services.Companies that sell those goods and services have lower profits and less money to pay workers Workers and investors have less money to spend on goods and services Decreased demand tends to lead to lower prices, forcing suppliers to cut production and lay off workers The growth rate of the economy slows
6 How Fiscal Policy Decisions Impact the EconomyWhen implementing fiscal policy, government has several tools at its disposal. If government leaders wanted to spur economic activity, which tools would they select?
7 The Limits and Costs of Fiscal PolicyThe Reality of Entitlements Much of the budget must go to entitlements which are required by law, so changes must come from Discretionary Spending Knowing the Future: Cannot know Delayed Results: Changes take Time Political Pressures: Decisions made to keep their jobs Coordinating Fiscal Policy: For policy to be effective, various branches and levels of government must WORK TOGETHER.
8 The Limits and Costs of Fiscal PolicyWhat does this cartoon suggest about the difficulties of creating effective fiscal policy?
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11 9.2 Fiscal Policy Options Classical EconomicsClassical economics taught that a struggling economy would recover on its own. But the Great Depression lasted for many years. Why do you think the economy took so long to recover during the Great Depression?
12 Keynesian Economics British economist: John Maynard KeynesDeveloped a new theory of economics to explain the Great Depression. “The General Theory of Employment, Interest, and Money” Wanted to develop an explanation of macroeconomic forces. Keynes wanted to give government a tool it could use immediately to boost the economy in the short run. His theories have had a huge impact on the changing role of government in the U.S. free enterprise system.
13 Keynesian Economics Versus Classical Economics:Changing Government’s Role in the Economy: The government can buy goods and services to increase employment Avoiding Recession: Government tracking of total amount of spending If spending drops, the government can take steps to fix it The Role of Automatic Stabilizers: Tools of Fiscal policy which increase/decrease automatically depending on changes to GDP and income Keynes: Focus on the workings of the whole economy (Macro) Classic: Equilibrium of supply and demand on individual products
14 Keynesian Economics: The Multiplier EffectThe multiplier effect helps explain how government spending boosts the economy. $1 spent or not taxed has a greater impact on the economy because of additional wages, investment etc.. that are generated
15 Keynesian Economics: Productive CapacityKeynes sought to achieve the full productive capacity of the economy. Productive Capacity: “Full-employment output” Maximum output the economy can sustain over a period of time without increasing inflation
16 Supply-Side EconomicsThe idea that the supply of goods drives the economy. Supply-side economics relies on increasing aggregate supply Keynesian economics tries to encourage economic growth by increasing aggregate demand It does this by focusing on taxes. In recent years, supply-side economics has had a significant impact on the U.S. economy and free enterprise system.
17 Incentives for business start-ups/angel investors Enterprise Incentives for business start-ups/angel investors Tax incentives for research and development Lower business taxes on profits arising from patents Capital Infrastructure spending (including telecoms, environmental assets Tooling up industries with new capital Human Factor Tax reforms and work incentives Quality of education and training for all Markets Creating extra competition between businesses Openness to trade and investment from overseas
18 Also known as Trickle Down TheorySupply-Side Economics Businesses get tax breaks Businesses produce goods and services and hire more workers Workers use their income from their jobs to buy good and services Also known as Trickle Down Theory The Relationship Between Taxes and Output: Tax cuts increases total employment The government collects more taxes at the lower tax rate
19 Lesson 9.3 The National Debt and Deficits
20 Budget Surpluses and DeficitsBudget Surplus: Excess revenue after paying expenditures. Deficits: If a Government dose not take in enough revenue to cover expenses they must find a way to cover those expenditures. They do this by creating or borrowing money.
21 Creating Money The government can print new money or electronically create money Works better with small deficits, but can cause problems with large deficits: More money in circulation= increased Demand=increased output…BUT!! Once economy reach FULL EMPLOYMENT output cannot increase= more money, same output=rise in price= a greater amount of money is needed to afford products….INFLATION This can also lead to HYPERINFLATION!!
22 Borrowing Money The government usually just borrows what is neededBonds borrows the money through selling bonds Once the bond matures it is ‘sold’ back to the government (with interest) Treasury Bills: Short Term Bonds (26 weeks or less) Notes: Terms of 2-10 years
23 Deficits and the National DebtThe Difference Between Deficit and Debt: Deficit: difference between what the government takes in (receipts) and the amount of money its spends (outlays) Debt: equal to all government debt outstanding Deficits add to debt and surplus subtracts from debt Measuring National Debt: Most often looked at as a percentage of GDP over time
24 Deficits and the National DebtWhen the government borrows money, it goes into debt. The national debt is the total amount of money the federal government owes. Every year that there is a budget deficit and the federal government borrows money to cover it, the national debt will grow.
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26 Measuring the national debt as a percentage of GDP is a way to compare debt at different times in history. How would you describe today’s debt in the context of the last 80 years?
27 The Impact of Debt The growth of the national debt during the Reagan administration led many to focus on the problems caused by a national debt. In general, three problems may arise from a national debt. Reduction in available funds for business and investment (crowding-out effect) High payment of interest to bondholders. The money designated for bond payment cannot be spent on other discretionary spending items. Foreign Ownership of Debt.
28 This diagram shows one way excess spending can hurt the economyThis diagram shows one way excess spending can hurt the economy. According to this diagram, what causes private businesses to be crowded out in the quest for investment?
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30 Measures to Control the DeficitReducing Deficits: Cut government spending. The government can cut its public spending to reduce its fiscal deficit. Tax increases. Higher taxes increase revenue and help to reduce the budget deficit. Economic Growth. Bailout: Financial support to a company which faces serious financial difficulty or bankruptcy Default: failure to pay interest or principal on a loan or security when due
31 Measures to Control the DeficitA Return to Deficit Spending: Spending exceeds revenue over a particular period of time US has had more deficit spending in the last 50 years than surplus
32 9.4 Monetary Policy OptionsThe Federal Reserve has the power to increase or decrease the amount of money in the United States. The Fed manipulates the money supply in order to stabilize the American economy.
33 Creating Money Coins and paper bills are manufactured in facilitiesThe Federal Reserve puts the manufactured money in circulation through the process of money creation. Money is created as banks loan out money not kept in reserve.
34 How would an increase in the reserve requirement affect money creation in this example?
35 Monetary Tool #1: Reserve RequirementsThe Fed uses reserve requirements to influence the money supply. Who or what is directly affected by a change in reserve requirements?
36 Monetary Tool #2: The Discount RateThe interest rate the Federal Reserve charges on loans given to banks Determines how much a series of future cash flow is worth as a single lump sum value today Determine the return bank customers earn on money they deposit and the cost they pay for money they borrow.
37 Monetary Tool #3: Open Market OperationsPurchasing and Selling Government Securities The Central Bank buys and sells bonds to regulate the money supply in the economy
38 What steps would lead to a reduction in the money supply through open market operations?
39 Open Market OperationsOpen market operations are the most often used of the Federal Reserve’s monetary policy tools. Can be conducted smoothly and on an ongoing basis The Fed changes the discount rate less frequently. Discount rate usually keeps the in line with other interest rates in order to prevent excess borrowing by member, which might threaten economic stability.
40 9.5 The Effects of Monetary Policy
41 Timing Monetary PolicyPoorly timed policy can create more instability than the normal business cycle. Which scenario shown in these graphs represents the least stable economy?
42 Anticipating Business CyclesThe Federal Reserve must do more than react to current trends. It must also anticipate changes in the economy. How should policymakers decide when to intervene in the economy?
43 Anticipating Business CyclesHow Monetary Policy Affects Inflation: Interest rate adjustments impact the levels of borrowing, saving and spending in an economy. Interest rates effect economy-wide demand for goods and services and the rate of inflation How Quickly Do Economies Self-Correct? The economy does not correct itself fast Markets adjust from disequilibrium to equilibrium. Output will return eventually to the natural rate level
44 Debating Monetary PolicyIn practice, the lags in the economy make monetary and fiscal policy difficult to apply. The lags and the general complexity of the national economy also make it difficult to sort out how different policies have affected the economy in the past. Economists have debated these matters for many years.