Methods to influence the economy

How can the government influence the economy in a recession and what is the problem?

Expansionary fiscal policy (expansive Fiskalpolitik)

• Lower Taxes

  → People/Businesses have more money
  → Higher consumption/ Higher investments
  → Higher Production/ economic growth

• Increase public spending (öffentliche/Staatsausgaben), e.g., infrastructure projects, subsidies (Subventionen)
  → Scrappage scheme (“Abwrackprämie”)

BUT: Rising government debt (steigende Staatsverschuldung)

What can a government in a boom to influence the economy ?

Contractionary/thight fiscal policy (restriktive Fiskalpolitik)

• Raise taxes
  → People/Businesses have less money
  → Lover consumption/ less investment
  → Lover production/economic growth

• Cut public spending
  →Lowering government debt

What can a Central Bank do in a recession to influence the economy and what is the problem?

Lower the key interest rate (Leitzins): Rate at which banks can lend money
→ Consumers save less (not attractive) and spend more (Loans are cheap)
→ businesses save less and invest more

Problem: Risk of inflation

What can a Central Bank do in a boom to influence the economy and what is the problem?

Rase the key interest rate
→consumers save more (saving is more attractive) but spend less (loans are expensive)
→ businesses save more and invest less

Problem: unemployment may rise

What are the two main ways a government can use to prevent high unemployment and high inflation?

1. Fiscal policy (Fiskalpolitik)

2. Monetary policy (Geldpolitik)

Used to expand or slow economic growth

How is fiscal policy defined and what are its primary tools

= Use of governmental spending (Staatsausgaben) and taxation (Steuern) to influence the economy

What is the multiplier effect in fiscal policy and why is it considered a powerful tool?

• Each dollar spent/not taxed by the government creates a change that is much greater than one dollar in national income

• e.g., government spends 1 billion euro on the health sector

  • People earn more

  • People spend more

  • Companies produce more rand hire new workers

  • New workers can spend more…

What is the difference between expansionary and contractionary fiscal policy, and what are their respective goals?

• Expansionary (Expansiv): used to increase output (e.g., to keep unemployment low)

• Contractionary (Restriktiv): used to decrease output (e.g.; to fight inflation)

What strategies do supply-side economists (= Angebotswirtschaft) like Milton Friedman advocate for in terms of fiscal policy?

• Supply-side economies/Monetarism (Angebotspolitik)

• Reduce (corporate) taxes and public spending

• Higher supply at lower prices to drive the economy

• Consumers will spend more

How do Keynesian economists, such as John Kenneth Galbraith, differ in their approach to fiscal policy compared to supply-side economists?

• Demand.side economists/Keynesianism (Nachfragepolitik)

• Increase taxes and public spending

• Higher demand (even if it’s by the government) will drive the economy

Summarize the basic tools of fiscal policy and differentiate between contractionary and expansionary fiscal policy

• Raise or lower taxes

• Raise or lower spending

• Raising taxes and lowering spending = contractionary fiscal policy

• Lowering taxes and raising spending = expansionary fiscal policy

What is monetary policy, and how does it influence the economy?

The way central banks influence the economy through the management of the money supply and interest rates

Explain the posses of money creation in banks and how it contributes to the overall money supply and interest rates

• Money in banks is created by deposits of firms/individuals

• Overall money supply can be controlled by raising or lowering interest rates

How can the government influence how much money banks are loaning out?

• Establish a central bank that gets money into circulation

• This bank (US: Federal Reserve; EU: ECB) sets up a nationwide required reserve ration (Mindestreserve) and raises or lowers the interest rates on loans to banks

What are the three tools of monetary policy and how can they be either cotractionary or expansionary?

The tools of monetary policy are:

• money creations

• managing discount rates

  open market operations (buying/selling government securities)

What are the main goals of both fiscal and monetary policy?

• keep unemployment low and curb inflation

• this leads to steady economic growth and helps consumers and producers survive business cycles