American
Government and
Politics Today
Chapter 16
Economic Policy
Introduction


A major economic policy issue is how to
maintain stable economic growth without
falling into either excessive unemployment
or inflation (rising prices).
Inflation, a sustained rise in the general
price level of goods and services.
Good Times, Bad Times




The U.S. economy experiences booms and busts.
The busts are called recessions.
 Recession, two or more successive quarters in
which the economy shrinks instead of grows.
Unemployment
 Full employment, an arbitrary level of
unemployment that corresponds to “normal”
friction in the labor market.
 Measuring unemployment.
Inflation
The Business Cycle: reoccurring booms and busts
More than a Century of Unemployment
Changing Rates of Inflation: 1860-Present
National Business Activity, 1880-Present
Fiscal Policy
Fiscal policy is concerned with achieving
economic policy goals through changes in
spending or levels of taxation.
 Keynesian Economics

 Government
Spending
 Government Borrowing
 Discretionary Fiscal Policy
 The
Thorny Problem of Timing
 Automatic Stabilizers
Deficit Spending and the
Public Debt

The government funds its deficit primarily
by selling U.S. Treasury bonds. Twenty
years ago, only 15 percent of these bonds
were held abroad. Today the figure is 40
percent.
Deficit Spending and the
Public Debt

The Public Debt in Perspective
 Net
public debt, the accumulation of all past
federal government deficits; the total amount
owed by the federal government to
individuals, businesses, and foreigners.
 Gross domestic product (GDP), the dollar value
of all final goods and services produced in a
one-year period.

Are We Always in Debt?
The Growth
of the
Net Public
Debt of the
Federal
Government
Net Public Debt as a Percentage of GDP
Monetary Policy



Monetary policy, the utilization of changes in the
amount of money in circulation to alter credit
markets, employment, and the rate of inflation.
Organization of the Federal Reserve System
Loose and Tight Monetary Policies. The Fed
implements policy by increasing or reducing the
rate of growth of the money supply.
 Increasing the rate of growth is loose monetary
policy.
 Reducing the rate is tight monetary policy.
Monetary Policy (cont.)
Monetary
policy has a problem with time
lags, but the Fed can make a policy change
more quickly than Congress.
The Fed announces changes to monetary
policy by raising or lowering the federal
funds rate, a government-controlled interest
rate for funds that banks borrow from each
other.
Monetary Policy (cont.)

The Fed Tackles Inflation
 Volkernomics

Monetary Policy versus Fiscal Policy. If
interest rates go high enough, people will
stop borrowing and inflation will subside.
Monetary policy cannot force people to
borrow money in a recession. While
monetary policy is more powerful against
inflation, fiscal policy is more effective
against recessions, because the
government does the borrowing itself.
World Trade
Imports
and Exports
 Imports,
goods and services produced
outside a country but sold within its borders.
 Exports, goods and services produced
domestically for sale abroad.
The
Impact of Import Restrictions on
Exports
 Protecting
American Jobs
 Quotas and Tariffs
 Free Trade Areas and Common Markets
World Trade Keeps Growing
The World Trade Organization


The WTO seeks to lower trade
barriers worldwide.
 What the WTO Does: The WTO also
has a dispute-resolution mechanism
that nations may use.
The WTO and Globalization.
 The WTO has become the focus of
those who fear the supposed
dangers of globalization. Neither the
United States nor any other country
has a veto power within the WTO.
The Balance of Trade and the
Current Account Balance



The balance of trade, or the difference
between the value of a nation’s exports of
goods and its imports of goods. The U.S.
balance of trade has been significantly
negative for many years.
The current account balance includes the
balance of trade in services, unilateral
transfers, and other items. It is also
negative and has been growing more so.
Are we borrowing too much from other
countries?
Taxes as a Percentage of GDP
The Politics of Taxes


Currently, Americans pay taxes that total
somewhat less than 30 percent of the
GDP.
Federal Income Tax Rates
 Loopholes
and Lowered Taxes
 Progressive and Regressive Taxation

Who Pays?
 Liberals
tend to favor progressive taxes.
 Conservatives either favor taxes that are less
progressive, or even flat or regressive.
Marginal Tax Rates
The Social Security Problem



Social Security was established in 1935
with the intent of providing a type of
insurance for a large segment of the
public.
Social Security is not a pension fund.
Workers Per Retiree
 Initially
for every recipient of Social Security
there were forty workers paying into the
general fund—a one-to-forty ratio. Today, the
ratio is more like one-to-three, and it will get
worse in future years.
What Will it Take to Salvage
Social Security?
 Raising
taxes
 Reducing benefits payouts
 What do you think will happen to
Social Security in 30 years? 60
years? 100 years?
A comparison
of
the number of
active workers
per
the number of
retirees.
Questions for Critical Thinking
 Why are the public and the economics
profession on such different wavelengths
when it comes to world trade?
 How much of a problem is it that the
United Sates has become so dependent
on money borrowed from foreign
countries? What might happen if
foreigners stopped lending?
Questions for Critical Thinking
 Is progressive taxation “fair”? Support
your argument that this form of taxation
is either fair or unfair.
 Which of the proposals to “fix” Social
Security have the most merit? Which do
you think would cause the most
problems?