Fiscal and monetary policy

Essential Reading

• Mark Horton and Asmas El-Ganainy, “Fiscal Policy: Taking and Giving Away,” International Monetary Fund. 

• “COVID-19 Government Stimulus and Financial Relief Guide,” Investopedia. Read only section on the United States.

Video Lecture

The federal reserve

feds chair often called 2nd most powerful official in D.C

Federal government taken control of the economy since the 1930s

1930s great depression

Federal government provided a safety net for the economically week and tightened regulation on businesses

the creation of the securities and exchange commission which regulates stock and bond markets

As well as the Social Security Administration which administers the Social Security program

Before the government didn’t get involved in the economy

since the depression the government has been more involved in the economy to ensure it is more consistent

Fiscal policy

a government's plan for managing the economy through taxation, spending, and borrowing

economic downturn feeds on itself

-firm cuts back on production, accelerating job loss

-consumers cut back on spending, furthering job loss

Keynesian economics- demand side policy

government should increase spending to put more money in peoples hand which would then spend and stimulate higher job growth

this was used for much of Franklin Roosevelts new deal

Reaganomics- trickle down economics

Government cuts business tax and upper incomes

wealthy men and businesses would invest more into supply side

increased production then creates jobs and more consuming

demand side policy

puts money directly into consumers hands emphasis on government spending to increase job growth

supply side policy

emphasises tax cuts for businesses and the rich in the hope they will invest more into industry supplying more jobs

Monetary policy

economy weak→ Increase in money supply → more money in circulation means firms and consumers have more money to invest and spend

he recognised the fed had the means to do this job

Feds Monetary policy tools

1. lower or raise interest rate on its loans to member banks

2. Lower or raise reserve rate (percentage member banks must keep on deposit)

3. Buy or sell securities (investments)

Buying securities gives more money to sellers

Supply side fiscal policy example

George W. Bush 2001 Recession

Tax cuts in the highest marginal rate on personal income from 39.6 to 35%

targeting high income tax payers so they would invest much of the money and give the economy a boost

Split democrats and republicans completely

supply side fits small government policy of the republicans

Effect of Bush tax cuts

The congressional budget office claimed the tax cuts had a modest impact on the economy

The tax cuts were too large to be paid back later and added 100 billion to US debt

it only added to the American economic divide

In 2008 Bush enacted a tax rebate which gave $300 per adult and dependent child for people earning under 75,000 and married couples over 150,000

Democrats backed this bill stronger than the Republicans

This cost $150 billion dollars

An even larger demand side stimulus bill was enacted by congress in 2009 under Obama costing $787 billion

This included road construction, updating the electricity grid, unemployment assistance and enabling states and local governments to retain their workers and services

the aim was to put money in peoples pockets

democrats backed it almost completely

on 3 republicans in both chambers backed this

This bill increased the number of full time-equivalent jobs by 2.0 to 5.2 million

however it added significantly to federal debt

Republicans blocked the second bill

Lowering the reserve rate was no longer going to work as banks had lots of cash in hand

In order to stimulate the demand for loans the fed rapidly dropped interest rates it charged member banks for loans

dropping from 5% to 1% by 2009 and the 0.25%

the fed also bought securities in at a fast rate

The fed then resorted to using quantitative easing where the fed creates money in order to buy securities from banks

The fed essentially just printed more money from 2009-2014

they spent over $3 trillion on quantitative easing

however the fed contributed the most out all the institutions for the economic recovery

monetary policy however holds that if money supply is excessive and there is too much money in circulation inflation will occur

Critics of the fed point out much of the money didn’t go into the consumers pocket but went to the banks and then the stock market and widened gap between poor and wealthy

monetary policy is more flexible than fiscal

the fed can change its interest rates quickly and is independent from partisan deadlock

the feds chair are nominated by executive but are able to operate on their own

The TARP programme bailed out banks and allowed people to loose their homes which put congress under much scrutiny

However the fed contributed much more money to banks yet didn’t face scrutiny as it was done in secrecy until it came out 3 years later. The fed outlined how they used it to mask Americas economic crisis

The fed need to be independent to protect minority rights

The economic downturn caused by the covid pandemic

economic fallout was rapid and severe

millions loss their jobs and 100,000s businesses shut down

Congress responded with several trillion dollars in stimulus spending

unemployment benefits and grants to firms were just a couple of things these grants covered

most received a direct cash payment from the federal government

Monetary

Fed cut interest to 0

and provided emergency loans

this prevented the toll from becoming even larger

Summary

Great depression was watershed moment for federal involvement in economy

Keynesian economics

democrats favour demand side fiscal increasing grants to consumers

republicans favour supply side fiscal cutting taxes for the rich and businesses

monetary policy- enacted through federal reserve, employs reserve rates, interest rates and the buying and selling of securities + quantitative easing