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Economic Policy and The Federal Reserve

Key Terms

  • Fiscal policy

    • Definition: Taxing and spending policies determined by the legislative and executive branches of government.
    • Focus: How the government decides its budget and allocates funds to stimulate or slow down the economy.

  • Monetary policy

    • Definition: Strategies that involve the control of the money supply to achieve economic objectives.
    • Components: Changes in interest rates and money available in the economy.

  • Interest rate

    • Definition: The price that borrowers pay lenders for the use of borrowed money, typically expressed as a percentage.

  • Inflation

    • Definition: Economic condition characterized by rising prices which reduces the purchasing power of currency.
    • Implication: As inflation rises, the value of money decreases.

  • Stagflation

    • Definition: A simultaneous occurrence of slow economic growth, high unemployment, and inflation.
    • Challenge: Difficult for policymakers to address as it encompasses contradictory economic indicators.

  • Market Economy

    • Definition: An economic system where the prices of goods and services are determined by supply and demand through interactions between buyers and sellers.

Economic Theories

Keynesian Economics/Keynesianism

  • Definition: Economic theory advocating for increased government expenditures and lower taxes to stimulate demand and pull the economy out of recession.
  • Notable Characteristics:
    • Government spending is essential during economic downturns.
    • Advocates for fiscal policies to react to economic needs.

Laissez-Faire Economics

  • Definition: Economic philosophy of free-market capitalism that opposes government intervention in the economy.
  • Notable Characteristics:
    • Belief that competition naturally regulates the economy.
    • Support for minimal government regulation and intervention.

Supply-Side Economics

  • Definition: Economic theory advocating for policies that increase production and supply as a means to stimulate economic growth.
  • Notable Characteristics:
    • Proposes cutting taxes to encourage businesses and individuals to invest in the economy.
    • Advocates for reduced government spending and deregulation.

Monetary Policy: The Federal Reserve

What does the Federal Reserve do?

  • Role: Acts as the central bank of the U.S. and manages the nation's monetary policy.
  • Objectives:
    • Control the nation’s money supply.
    • Stabilize prices and ensure maximum employment.
    • Maintain moderate long-term interest rates.

What kind of agency is the Federal Reserve?

  • Type: An independent agency within the federal government.

Who controls the Federal Reserve System?

  • Leadership: Managed by a Board of Governors, with a chair appointed by the President of the United States.
  • Oversight: The Federal Reserve is subject to oversight by Congress.

How does the Fed control the nation's money supply?

  • Strategies:
    • Adjusting interest rates to either encourage or restrict borrowing.
    • Implementing monetary policies to promote or slow economic growth as needed (e.g., lowering taxes, regulating spending).

How does changing interest rates affect the nation's economy?

  • Effects:
    • Lowering interest rates can stimulate economic activity by making borrowing cheaper.
    • Raising interest rates can help combat inflation and stabilize the economy by reducing spending and borrowing.