A Managed Economy

1
A Managed Economy

• Founders influenced by Adam Smiths invisible
  hand (The Wealth of Nations) 1776.
• The Constitution limits the federal governments
  role.
• Gradual change in that role New Deal, Great
  Society.
• Modern public expectations.

2
What do we expect of government?

• Who gets the credit or the blame for the economy?
• Is it realistic to expect laissez-faire to
  produce a successful economy?
• Until the Great Depression it was generally
  accepted that free markets could and should
  produce stability.

3
The Goals of Economic Policy

• Economic growth
• Low unemployment
• Stable prices
• A positive balance of payments
• Minimizing negative externalities
• Supporting key economic sectors

4
The Tools of Macroeconomic Policy

• First, whats that?
• Fiscal Policy Governments actions affecting
  spending and taxing levels.
• Monetary Policy Governments actions affecting
  money supply and interest rates.

5
Fiscal Policy

• Increases and decreases in government spending
  and or taxation economic results.
• Spending increases/ decreases
• Tax increases/ decreases
• Spending our way out of the Depression
• Growth and stability that resulted from Social
  Security.
• Associated with Keynesian economic policy.

6
Keynesian Economics

• English economist John Maynard Keynes
  (1883-1946) theory that government should use
  fiscal policy to stimulate production.
• That means spending, even deficit spending, to
  prime the pump.
• That means cutting taxes, even if it results in
  deficits, to prime the pump.
• Taxes would then be raised and or spending
  decreased later to pay down the debt, but only
  when production could sustain itself.

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Spending Came to Dominate Keynesianism

• The advocates of Keynesianism have come to prefer
  spending to tax cuts as a method of stimulating
  the economy.
• Closest to policy preferences of liberal
  Democrats.____Greenberg
• Were all Keynesian now. _President Nixon

8
Monetary Policy

• Government actions affecting the supply of money
  and interest rates.
• Did you write that down again?
• Who has the power to manipulate the money supply
  and interest rates?
• Where do they get that power?

9
The Federal Reserve System

• The Fed was established in 1913. What else was
  going on then?
• It has been the subject of much suspicion and
  criticism.
• What is it?

10
The Federal Reserve System

• Made up of
• The Federal Reserve Board. Seven members
  appointed by the president for 14-year terms (
  with senate consent). One of them is designated
  as chairman by the president for a
• 4- year term.
• Twelve regional Federal Reserve Banks.
  BNPCRACSMKDS
• The Federal Open Market Committee. Consists of
  twelve members the seven members of the Board of
  Governors, the president of the Federal Reserve
  Bank of New York and four of the remaining
  eleven Reserve Bank presidents, who serve
  one-year terms on a rotating basis.

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BNPCRACSMKDS
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Three ways the Fed manipulates the supply of
money and interest rates.

• The Reserve Requirement FRB adjusts the amount
  of a banks deposits that must be held on
  reserve.
• The Discount Rate The FRB adjusts the interest
  rate charged to banks when they borrow from the
  Federal Reserve.
• Open Market Policy FOMC buys or sells government
  securities from the private sector.

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Similarities between Fiscal and Monetary Policy

• Both attempt to produce economic results by
  encouraging activity and growth with a goal of
  full production.
• Both traditionally have seen the balance of
  unemployment and inflation as the measure of
  success of any economic policy.
• Both seek to stimulate the economy by stimulating
  demand. Whats that?

14
An alternative theory Supply-Side Economic
Theory.

• Though not new at the time it was a controversial
  theory a quarter-century ago.
• Arguably it is now the status quo politically,
  even if it has not gained widespread acceptance
  among economists.
• Unlike Fiscal and Monetary Policy, its advocates
  seek to stimulate the supply side of the economy
  rather that the demand side.

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How can government policy stimulate the supply
side?

• Business-friendly tax policies.
• Business-friendly regulatory policies,
• You get more of what you subsidize and less of
  what you tax ____I dont know who Im quoting
  here, but he sure is smart.

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The Laffer Curve

• At the heart of supply-side economics from the
  mid-1970s forward.
• Arthur Laffer was a USC economics professor.
• The Laffer Curve was popularized by a witness to
  a 1974 meeting where Laffer drew the curve on a
  napkin for Dick Cheney.

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The Laffer Curve
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Economic Heresy

• Cutting taxes to stimulate the economy has, as
  weve seen, been widely accepted---by monetarists
  and Keynesians as well.
• Cutting taxes AND increasing tax revenues BY
  stimulating the economy was scoffed at early on.
• Voodo-Economics_George Bush (1980)

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Radical Ideas in and out of Congress

• Kemp-Roth Tax Bill 1978 proposes drastic cuts in
  income tax rates TO increase tax revenues.
• A natural fit for the presidential candidacy of
  former California Governor Ronald Reagan.

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GOP Has been on the Voodo Diet for Twenty-Five
Years
21
Reagans 1981 Inaugural Address
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Reagans 1981 Inaugural Address
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Reagan and the Supply-siders long-term effects.

• Debate in election after election since the
  1980s has been about HOW MUCH to lower taxes.
• The Republican Party, which resisted Reagan and
  the supply-siders until Republican voters decided
  otherwise, has come to hold his policies up as
  the ideal to be emulated.

24
A Recent Headline

• India Swings on the Laffer Curve
•  By Jude Wanniski Monday 07 March 2005, 1558
  Makka Time, 1258 GMT  
• Aljazeera.net

25
Republicans and Democrats will never agree about
the results of the Reagan presidency or
supply-side economics.

• The biggest source of disagreement is over the
  huge federal deficits during the Reagan years
  which led to a greatly increased national debt.
• Who is to blame?
• Is it even a problem?
• Actual dollars vs. percentage of GDP.

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Something to Leave to Our Children
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  7,798,280,607,715 as of 4-14-2005
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National Debt 1940 to Present in Actual Dollars
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Some argue that what really matters is the debt
to GDP ratio.