Economic Policy Making
Two Major Worries Regarding The
U.S. Economy
 Unemployment Rate
 Inflation
– Consumer Price Index (CPI)
Instruments for Controlling the
Economy
 Since the Great Depression and the New
Deal, government has been actively
involved in steering the economy.
 The principle of laissez-faire, keeping
government out of the economy, is largely
gone.
 The most important tool the government
has to manage the economy is its control
over the money supply.
Monetary Policy
 An economic theory called monetarism holds
that the supply of money is the key to the
nation’s economic health.
 Monetarists believe that government should
control the money supply to encourage
economic growth and restrain inflation.
 Politicians worry constantly about the money
supply because it affects the interest rates we
(constituents) all pay.
The Federal Reserve System
 The “Fed”
 Created by Congress in 1913 to regulate the
lending practices of banks (the money supply).
 The Federal Reserve System is intended to be
beyond the control of the president and Congress.
– Its 7 member Board of Governors is appointed by the
president and confirmed by the Senate
– Board members are given 14 year terms
How the Fed Works
 Federal Open Market Committee studies vast
amounts of economic data.
 The FOMC sets the “federal funds rate” which is the
rate banks charge each other for overnight loans.
 The Fed purchases and sells government bonds from
banks.
 By buying or selling bonds from banks, the Fed
determines whether banks have more or less money
to lend out.
 The more money banks have to lend out, the cheaper
borrowing is.
 If banks have less to loan, loans become more
expensive and interest rates rise.
The Fed Can Profoundly Influence
the State of the Economy
Fiscal Policy
 Describes the impact of the federal budgettaxing, spending, and borrowing- on the
economy.
 Congress and the president shape fiscal
policy.
 The use of fiscal policy to stimulate the
economy is most often associated with
advocates of big government.
Keynesian Economic Theory
 Named after English economist John Maynard
Keynes.
 “Demand-side economics”
 1936: Keynes emphasized that government spending
could help the economy weather its normal ups and
downs.
 If businesses were not able to expand, it would be up
to the government to pick up the slack.
 If no jobs were available, government should create
them.
 Democrats and Republicans alike adhered to the
basic tenets of Keynesian economics until Reagan.
Supply-side Economics
 Reagan’s economic advisors proposed a radically
different theory based on the premise that the key
task for government economic policy is to
stimulate the supply of goods, not their demand.
 To supply-siders, government soaked up too much
of the Gross Domestic Product
 By taxing too heavily, spending too freely, and
regulating too tightly, government curtailed
economic growth.
 Republicans have come to accept supply-side
economics, especially the policy of tax cuts.
Obstacles to Controlling the
Economy
 “Political business cycle”
 Government makes economic policy very
slowly.
 Budget process is dominated by
“uncontrollable expenditures.”
 Private sector dominates the U.S. economy.
Economic interests far outnumber
any other kind of interest groups
 Business
 Consumers
 Labor
Business and Public Policy:
Regulation
 Suspicions over concentrated power has led to
government regulations over business.
– Multinational Corporations- businesses with vast
holdings in many countries with huge budgets.
– Antitrust policy: to ensure competition and prevent
monopoly. Government can sue a company in court.
– The main regulatory agency responsible for regulation
of business practices is the Securities and Exchange
Commission (SEC). They regulate stock fraud and keep
an eye on business accounting practices
Business and Public Policy:
Subsidies
 Federal Government is the principle source
of research and development funding in the
U.S.
 The Department of Commerce serves as a
storehouse of assistance for businesses:
data on products and markets; helps
businesses export their wares, protects
inventions
Consumer Policy
 Years ago the motto was “let the buyer beware.” Consumers
and their interests were ignored.
 The first major consumer protection policy in the U.S. was the
Food and Drug Act of 1906, which prohibited interstate
transportation of dangerous or impure foods and drugs.
 Today the FDA (Food and Drug Administration) has broad
regulatory powers over the manufacturing, contents, marketing
and labeling of food and drugs.
 Consumerism was a sleeping political giant until the 1960’s and
consumer advocate Ralph Nader.
 1960’s and 1970’s saw a flood of consumer protection
legislation and the CPSC was created.
 Consumer Credit Protection Act: Stipulates that whenever you
borrow money, you must be informed of the exact amount of
interest you’ll pay
Labor and Government
 1935 National Labor Relations Act (Wagner Act)
guaranteed workers the right to collective
bargaining.
 Taft-Hartley Act tipped legislation the other way in
1947; government was given some power to halt
strikes and states could adopt “right to work” laws
(free-rider problem is the result).
 Some big victories for minimum wage and
unemployment compensation.
 Unions have fallen on hard times
Liberals vs. Conservatives
 What they argue about when it comes to
economic policymaking is the scope of
government involvement in the economy.
 Liberals favor more regulations over
businesses, conservatives favor less.
 Whereas liberals focus on the imperfections
of the market and what government can do
about them, conservatives focus on the
imperfections of government.