Unit 5: Monetary and Fiscal Policy Combined

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Unit 5 Monetary and Fiscal Policy Combined
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Goals of Economic Policy

• Stabilizing the economy
• Keeping employment high
• Price level stable
• If aggregate demand is too low, there will be
  unemployment
• If aggregate demand is too high, there will be
  inflation

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• Try to think of TWO fiscal policy tools Could you
  remember any???
• Government spending
• Taxes
• Income tax brackets
• Unemployment compensation
• Stock and bond returns

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Fiscal policy is one of the two demand management
policies available to policy makers.

• Government expenditures (i.e. government
  spending)
• Level and type of taxes
• Both are considered discretionary fiscal policy
  tools

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Basically..

• This is how the government can increase aggregate
  demand in an effort to increase our productivity
  (or real GDP)
• Also a way to increase employment during a
  recession

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Government Spending

• Affects the economy directly by increasing the
  demand for goods and services
• When the government increases spending, it
  initiates a multiplier process that results in a
  greater increase in total spending than the
  initial increase
• Will increase aggregate demand (AD), shifting it
  to the right
• In the short run, this will result in an increase
  in real GDP and the price level
• Considered expansionary if the change increases
  AD and/or real GDP
• Examples 700 billion Wall Street buy out

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Changes in Taxes

• Does not directly change real GDP
• Changes in taxes affect the disposable income of
  households or businesses
• The changes are felt through consumption spending
  and investment spending
• An increase in taxes will decrease disposable
  income
• A decrease in disposable income will decrease
  consumption (but by less than the increase in
  taxes) ---- some of the additional cost of taxes
  will come out of their savings

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Automatic Stabilizers

• There are many tools embedded in the economy that
  respond to the different phases of the business
  cycle automatic stabilizers
• Called automatic b/c they adjust without an
  action by Congress or the President
• They limit the increase in real GDP during
  expansions and reduce the decrease in real GDP
  during recessions

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Income Tax System

• As your nominal income increases, you move into a
  higher tax bracket and pay more taxes
• This limits the increase in disposable income and
  consumption
• Vice-versa, if you take a pay cut you move to a
  lower bracket and therefore have lower taxes

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Unemployment Compensation

• As the economy slows and unemployment increases,
  the income of the unemployed does not fall to
  zero
• Unemployment comp. provides a base level of
  income and the negative impact on real GDP is
  lessened

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Stock and Bond Returns

• Many corporations establish the dividends they
  pay on shares of stock and maintain this payout
  for several years
• Thus, dividends do not follow swings of the
  business cycle
• Bond payments maintain their value throughout
  their lifetime

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Three Monetary Tools

• 1. Open Market Operations buying and selling
  bonds
• 2. Reserve Requirements changing the reserve
  ratio at banks
• 3. The discount rate

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How much time do these policies take to get
initiated???

• Inside lag the time it takes for data to be
  collected, policy makers to recognize that policy
  action is necessary, the decision about which
  policy should be taken and the implementation of
  the policy
• In Washington that could take FOREVER!

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How much time does it take these policies to
actually impact the economy?

• Outside lag the time it takes the economy to
  respond to the new policy
• it takes a varying amount of time for the
  different policies

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Morton 43

• Were going to work on this together, in class