ECONOMIC
POLICYMAKING
U.S. economy:

Most important issue facing politicians
#1 indicator of political success is economy’s success

Capitalism

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Socialism?

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Free market system; individuals & corporations own the
principal means of production
Who owns the means of production?
Mixed Economy – U.S.

Free market system based on supply & demand BUT gov’t
plays a regulatory role
 regulator, consumer, tax collector, employer, borrower
Two major economic worries:
Unemployment & Inflation

#1 - UNEMPLOYMENT



Always stays at about 3% due to job turnover, etc.
(5% or less is average)
Politicians worry as it nears
double digits
Which party is most willing
to accept higher inflation to
keep unemployment down?



Democrats - have broad appeal
to working class
U.S. current rate – 5.0%
FL current rate – 5.6%

Orlando – 4.5%
MEASURING UNEMPLOYMENT

Number of unemployed identified
monthly by Bureau of Labor Statistics



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
from a monthly household survey of
60,000 families who represent a crosssection of the U.S.
Unemployment rate does NOT include
dropouts and makes no distinction
between full and part time employees
It’s always adjusted for seasonal
unemployment.
It’s an average for the nation, not
particular regions.
“Full employment” is 4% - makes
allowances for normal movement
between jobs
Two major economic worries:
#2 – INFLATION

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
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Too much $ in circulation – prices
up
Inflation = a general increase in
prices across an economy.
Over the years, prices generally
go up.
Inflation shrinks the value, or
purchasing power of things.
Republicans, who appeal to many
in investor/business class, seek to
avoid inflation at risk of rising
unemployment
Current Inflation Rate = 0.5%
Measuring Inflation
•
•
•
•
To measure inflation, economists
compare price levels.
– To help them calculate price level,
economists use a price index
CONSUMER PRICE INDEX – CPI
– is best known price index
Reports on price changes for about
90,000 items in 364 different
categories
Items in the basket reevaluated every
10 years
INFLATION

Major Causes?
 Growth of Money Supply
 Excessive Monetary Growth
 Money supply grows too fast….value down…prices up
 Changes in Demand
 Output can’t keep up with demand…shortages…prices
up
 Changes in Supply Costs
 Rising input costs (labor…unions) push up costs of
products
 Wage-Price Spiral
 Higher prices..workers want higher wages..producers
try to recover by setting higher prices……
CONSEQUENCES OF
INFLATION



Dollar buys less
 What does it mean if the inflation
rate is 10%?
Affects Income
 Causes people to change spending habits
 Hard on fixed incomes:
retired, etc.
 Encourages speculation - people trying to take advantage
of higher prices and buy luxury items expecting price to
go up
Affects Interest Rates
 If the inflation rate is higher than the bank’s interest
rates, savers lose money
Recession vs. Depression?




RECESSION = prolonged economic contraction
 6 to 18 months usually; Unemployment Rate 6 – 10%
 The Great Recession?
DEPRESSION = long, severe, deep recession
 Lasts longer; more unemployment; low output
WHY does a high unemployment rate correspond with a
recession?
 Because, by definition, a recession is a stage of the business
cycle that is marked by decreased productivity and a high
rate of unemployment.
Interactive map of the Great Recession http://www.latoyaegwuekwe.com/geographyofarecession.html
Recessionary Cycles
CONTROLLING THE ECONOMY

TWO TOOLS: Monetary &
Fiscal Policy

What’s the difference?

Monetary Policy

Money Supply
 Private control since Fed
Reserve Board controls the
amount of $ in circulation
Fiscal Policy
 The Budget
 Public control – federal
government regulating taxes
& expenditures

FISCAL POLICY – The Budget

Taxing & Spending & Borrowing


By Congress & P (although
Constitution gives Congress the most
economic power)
Liberal theory – KEYNESIAN



John Maynard Keynes
Government as active participant –
spend $ to stimulate demand & help
a lagging economy
Deficit spending not a problem
Keynesian Economics
 British
economist John Maynard Keynes
- a new theory to explain the Depression.
 Keynes
argued that the Depression was
continuing because neither consumers nor
businesses had an incentive to spend enough
to increase production.
 So… the only way to end the Depression,
would be to find a way to boost demand.
 Government
should step in and spend
more money in order to boost demand.
 The
government could make up for the
drop in private spending by buying goods
and services on its own…. even if it’s
deficit spending
FDR’s New Deal
Demand-side
Economics

Conservative theory –
SUPPLY-SIDE ECONOMICS

Decrease government’s
involvement in the economy



Big government taxes too heavily,
spends too freely, regulates too
tightly, and thereby actually curbs
economic growth
Stimulate supply of goods so cost
of goods declines
Greater production
accomplished through tax cuts &
spending cuts on social programs


Based on the idea that the supply of goods
drives the economy.
Supply-side economists believe that taxes
have a strong negative impact on economic
output.
•
Argument is that a tax cut increases total
employment so much that the government actually
collects more in taxes at the new, lower rate.
•
•
•
•
The federal budget basically consists of
two parts:
– Revenues — taxes
– Expenditures — spending programs
When revenues and expenditures are = the budget is balanced.
How often do you think the budget is actually balanced?
– Almost never balanced; it either runs a surplus or a deficit.
How does the federal government usually respond to a budget
deficit?
– By borrowing money.
– From who?
– Why doesn’t it just create new money?
Budget Deficits and the National Debt
•
•
•
•
Budget surplus = a situation in which budget
revenues exceed expenditures
Budget deficit = a situation in which budget
expenditures exceed revenues
National debt = the total amount of money the federal
government owes to bondholders
Effects of budget deficits on the national debt?
•
•
A budget deficit leads to an increase in the amount that the
government has to borrow.
As the government borrows more money, the national debt
increases, which means there are fewer funds available for
investing.
Difference Between Debt & Deficit




The deficit is the difference between expenditures and revenues
in one year.
 So … it will equal the amount of money the government
borrows for one fiscal year
The debt is the sum of all government borrowing before that
time (minus the borrowing that has already been repaid)
So… every year that there is a budget deficit, the federal
government borrows money to cover it and the national debt
then increases.
Current National Debt?
Regan’s Description of
a Trillion Dollars:


In a speech to Congress in February 1981:
“A few weeks ago I called such a figure, a trillion
dollars, incomprehensible, and I’ve been trying ever
since to think of a way to illustrate how big a trillion
really is. And the best I could come up with is that if
you had a stack of thousand-dollar bills in your hand
only 4 inches high, you’d be a millionaire. A trillion
dollars would be a stack of thousand-dollar bills 67
miles high.”
GOVERNMENT’S SOURCES OF REVENUE

THREE MAJOR
SOURCES:
1. Personal &
corporate income
tax
2. Social insurance
taxes
3. Borrowing
(Bonds)
Two Primary Types of Taxes

#1 - PROGRESSIVE
 People taxed at
increasing percentage
rate as income rises.
 Proportion of tax
paid increases as
income increases.
 INCOME TAXES!!!

16th Amendment
Taxes are classified as progressive or regressive according to
the way the tax burden changes as income changes.
LOST INCOME:
FED TAX “LOOPHOLES”
• Loophole is a tax break or tax benefit to the
individual; it is lost income to federal gov’t
• Loopholes allow you to reduce your taxable
income
• Examples of Loopholes:
• Deductions for mortgage interest
• Charitable contributions, etc.
• Mostly benefit middle & upper income taxpayers
& corporations since poor don’t buy homes, etc.
Married Taxpayers Filing Jointly
2015 Tax Brackets
Individual Taxpayers
2015 Tax Brackets
When are personal income taxes due?
Tax Returns must be postmarked by midnight,
April 15th!
Tax Return = form used to declare your income (for the previous
calendar year) and determine how much of it is taxable.
Two Primary Types of Taxes

#2 - REGRESSIVE
 Tax levied without regard to a
taxpayer’s income or ability to pay
 Puts higher percentage rate of
taxation on lower incomes
 Percent paid decreases as income
increases
 SALES TAXES!!
 Not a tax based on income, but
based on a percentage of what
you purchase
 Affects people’s incomes in a
regressive manner
Sales Taxes have a regressive effect:

For example:


A person with $20, 000/ yr income buys $5,000 of
necessities.
 5% sales tax = $250 = %1.25 of income
Person with $100,000/ yr income buys $5,000 of
necessities.
 5% sales tax = $250 = %.25 of income
 So in reality, they put a higher rate of taxation on
low incomes than high ones --- they take a higher
rate of the income from low income earners
SOCIAL
INSURANCE TAXES
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Paid by both Employers and Employees
For example: SOCIAL SECURITY
Social Security fastest growing source of government income
 How is it an inter-generational contract?
These taxes do NOT go into the general budget fund but,
instead, are earmarked for a specific purpose – they are an
uncontrollable expenditure
Social Security Tax

Social Security Act – 1935
 A reaction to the Great
Depression
 Intended to provide
unemployment
compensation to workers
who lost their jobs
 Originally a 2% tax – half
from employee, half from
employer
 Now a 12.4% tax – 6.2%
payroll deduction from
employee & employer
pays in 6.2%
 Current problem?
ENTITLEMENT PROGRAMS
• Mandatory, not discretionary spending – difference?
• Social welfare programs that people are entitled to if they meet
certain eligibility requirements such as age or being at a particular
income level.
• Make up bulk of government spending!
•Social Security (50 million Americans)
• Retired, disabled
•Medicare (42 million Americans)
• Hospital care, physicians & medical services
•Medicaid
Why are
• Low-income families, elderly in nursing homes entitlement
program
• Shared cost with state governments
costs going
•Unemployment compensation
up?
•Veterans’ pensions
•Food stamps; WIC
Federal government is limited in how much it can
change spending levels due to entitlement programs.
MONETARY POLICY
Manipulating the Money Supply

Managed by the Federal Reserve Board (1913)
Board of Governors appointed by P and confirmed by
Senate & serve 14-yr. terms (insulates them from political
pressure)

Acts independently & regulates monetary policy in 3 ways
1.
Manipulating the interest rate at which loans are given
2.
Manipulating the amount of reserves --- $ banks must
have available (also controls interest rates)
3.
Adds to the money supply by buying bonds; decreases
money supply by selling bonds
Chairperson of the Fed is now Janet Yellen


STRUCTURE OF THE FED

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Owned by member banks: all national banks
Twelve Districts with Directors/Presidents

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but supervised by Fed in DC
Board of Governors – 7 members

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appointed by P & approved by Senate
14 year terms, staggered
Janet Yellen
 first female chairperson
The Federal Reserve System
Obstacles to Controlling the Economy:

“Government can do about as much to control the
economy as the average parent can do to control
the average teenager.”

PRESIDENT:
 could try to manipulate economy before elections…
rarely happens
GOVERNMENT:
 WORKS SLOW!
UNCONTROLLABLE EXPENDITURES:
 like Social Security; no control over amount
CAPITALISM:
 private sector larger than public sector & so dominates
economy
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Private Business Control of
the Economy:

Multinational corporations control much of country’s
assets

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Mergers have flourished since early 1980s

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Microsoft, GE, Coca Cola, Apple, Exxon
Wal-Mart - world’s largest company; China’s biggest
customer
For example, only 2 credit giants: Visa and Mastercard
Antitrust laws allow Justice Dept. to sue monopolies –
to ensure free competition
Microsoft case – Clinton -- Gates “loses” but….
International Trade
NAFTA




Created world’s largest free trade zone
Removed or reduced many, but not all, tariff
barriers among U.S., Canada, Mexico
Signed in December 1992; in force by January
1994
Increases market access for goods to move across
borders in North America.
International Trade
World Trade Organization

January 1995 – to promote free trade – to supervise and
liberalize international trade


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Countries reducing tariffs, quotas…some tariffs dropped
altogether
Sets the rules for international commerce
Helps settle disputes between nations

Authorizes trade sanctions
The WTO is a place where member
governments go to try to sort out the
trade problems they face with each
other - so…..why the negativity?
• Human rights issues
• Environmental issues
2008 AP Gov’t Exam, Question #3
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Fiscal policy and monetary policy are two tools used by the federal
government to influence the United States economy. The executive and
legislative branches share the responsibility of setting fiscal policy. The
Federal Reserve Board has the primary role of setting monetary policy.
(a) Define fiscal policy.
(b) Describe one significant way the executive branch influences fiscal
policy.
(c) Describe one significant way the legislative branch influences fiscal
policy.
(d) Define monetary policy.
(e) Explain two reasons why the Federal Reserve Board is given
independence in
establishing monetary policy.


Part (a) Define fiscal policy. (1 point)
Acceptable definitions include:



Taxing and/or spending
The budget
Part (b) (1 point) Acceptable descriptions of a significant
way the executive branch influences fiscal policy include:



The president proposes/prepares the federal budget.
The president signs/vetoes legislation (related to taxing, spending, and
borrowing, not generic).
The White House Office of Management and Budget (OMB)
recommends the budget.

Part (c) (1 point) - Acceptable descriptions of a
significant way the legislative branch influences fiscal policy
include:




Congress passes the federal budget.
Congress acts on tax and spending legislation.
The Congressional Budget Office (CBO) advises Congress on
economic policies.
Part (d) (1 point) - Acceptable definitions of monetary
policy include:

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Regulating the money supply
Adjusting bank reserve requirements
Controlling inflation/deflation
Adjusting interest rates to regulate the economy.

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

Part (e) One point is earned for each of two explanations of
why the Federal Reserve Board is given independence in
establishing monetary policy. Acceptable explanations
include:
• It removes politics from monetary policy decision making.
• Congress/ P can abdicate responsibility for difficult
decisions by delegating decision-making power.
• The Federal Reserve Board relies on expertise when making
decisions.
• The Federal Reserve Board makes economic policies
efficiently.
THE BUDGET MAKING
PROCESS
Congress, the President, and the Budget:
A BRIEF REVIEW
on the following 8 slides
The Federal Budget
• THE PROCESS:
– P’s arm – Office of Management & Budget advises
– But CONGRESS controls & sets the budget.
•
•
•
•
Budget is a policy document allocating burdens (taxes)
and benefits (expenditures).
Government collects $$$ by taxes and spends it via
expenditures.
If tax allocations are higher…it’s a surplus (it did happen
in ’99!)
If expenses are higher. . .it’s a deficit which is then added
to the national debt and you get a shortfall in the trillions
…and it takes far too much of the current budget just to
pay interest on the debt!
FEDERAL
EXPENDITURES
• Primary Federal Expenditures:
– Social Service State (social security, Medicare, etc.)
– Interest on the national debt
– National Defense
• Rise of large governments is one of most important
changes seen in 20th century
– American governments (national & state) spend
annually an amount equal to 1/3 of the GDP
– BUT, US actually has one of the smallest public sectors
among Western nations relative to the size of the GDP
• Rise of the NATIONAL SECURITY STATE has
caused much of the growth
RISE OF SOCIAL SERVICE STATE
• Biggest slice of budget goes to income security
expenditures – policies of direct & indirect aid to
elderly, poor, needy
• Makes up over 1/3 of the federal budget
• Social Security Act 1935
– Disability insurance added to it in 1950
– Medicare 1965 – hospitals/doctors for elderly
• Prescription benefits added -2003
– Medicaid also added in 60s
• aid to the poor/needy
• Other social service expenditures
involve health, education, job training
INCREMENTALISM &
UNCONTROLLABLE EXPENDITURES
• INCREMENTALISM prevails in budget making:
– Increase last year’s budget by an “increment” to satisfy
this year’s budget
– What do you think Executive Branch agencies do when making their
budget requests?
• UNCONTROLLABLE EXPENDITURES have increased in
federal spending – are now about 2/3 of spending –
“mandatory spending” such as
– ENTITLEMENTS – if you qualify, you get them, no
matter what the cost to the government, even if all the
funds are depleted…
• Expenditures are determined by how many people are eligible for
the program….Congress has obligated itself to pay X level of
benefits to Y number of recipients.
• SOCIAL SECURITY, MEDICARE!!!
• Difference between Mandatory and Discretionary Spending?
The Budgetary Process
• POWER OF THE PURSE belongs to Congress!
– House Ways & Means Committee deals with taxing
aspects; House Budget Committee; Senate Budget
Committe
• OFFICE OF MANAGEMENT AND BUDGET (OMB)
– P’s Budgetary Arm
– Supervises preparation of the federal budget and advises
the P on budgetary matters
• CONGRESSIONAL BUDGET AND IMPOUNDMENT
ACT OF 1974:
– P required to spend the funds that Congress appropriates
– Ends P’s ability to kill programs by withholding funds
(Nixon did this quite a bit)
The Budgetary Process:




Federal fiscal year is Oct. 1 - Sept. 30
OMB starts reviewing budgetary requests in Fall
P submits the budget recommended by OMB in January
Then, 2-step process begins in Congress:
1. Authorization bill – authorizes/changes a program
or entitlement & sets a spending limit on it – what
they might get
2. Appropriations bill – final funding of the programs
set by the authorization bill; can’t go higher, but
can give lower amounts.
 Huge numbers in budget – for ex., in 2011 Obama’s
budget called for 3.83 trillion in spending
 2013 budget - $3.7 trillion … but revenues only 2.56
trillion so…..deficit
• Both houses of Congress must agree upon FIRST BUDGET
RESOLUTION by May of each year – sets the overall revenue
goals and spending targets
 Budget committee in each house – lots of bargaining all
summer
 CONGRESSIONAL BUDGET OFFICE (CBO)
 Congressional Budgetary arm – reviews; gives advice to
Congress, forecasts of revenues, etc.
• Congress to agree to SECOND BUDGET
RESOLUTION by September
– Sets binding limits on taxes and spending for fiscal year
beginning Oct. 1
• If Congress does not meet Oct. 1 deadline for new
budget for the new fiscal year…?
– Passes weekly continuing resolutions to keep gov’t going.
– Do the same thing as last year with same amount of $