Fiscal and Monetary Policies

Introduction to Fiscal and Monetary Policies

  • Unit IV: Finance and Banking

  • Unit V: Inflation & Unemployment

  • Stabilization Policies

  • Presenter: Mr. Griffin, AP Economics – Macro

Understanding Debt

  • Question raised: What does it indicate about a person's financial management if they are $380,000 in debt?

Basics of Fiscal and Monetary Policy

Fiscal Policy

  • Main Functions:

    • Government spending

    • Taxing

    • Borrowing

  • Level: Conducted at the Government level

Monetary Policy

  • Definition: Regulates the economy by controlling the money supply and interest rates

  • Authority: Managed by the Federal Reserve System

Part I - Fiscal Policy

Federal Budget Overview

  • Fiscal Year 2012 Budget of the U.S. Government

  • Prepared by: Office of Management and Budget

  • Website for reference: budget.gov

Key Players in Fiscal Policy

  • Executive Branch

  • Congress

    • Revenue from Taxes

    • Outlays from Spending

    • Borrowing

  • Key Issues:

    • Slow processes

    • Political influences

Government Spending Types

Federal Discretionary and Mandatory Spending

  • Discretionary Spending:

    • Portion of the budget that goes through the annual appropriations process

  • Mandatory Spending:

    • Required by statute, e.g., Social Security

Annual Budget Process Steps

  1. Step 1: President submits a budget proposal

  2. Step 2: Congress passes a budget resolution

  3. Step 3: Congressional subcommittees 'markup' appropriation bills

  4. Step 4: House and Senate vote on bills and reconcile differences

  5. Step 5: President signs each appropriation bill and budget is enacted

  • Link for detailed timeline: http://www.nationalpriorities.org/Federal+Budget+Timeline

Expansionary Fiscal Policies

  • Objective: Encourage economic growth

    • Strategies: Increase spending and lower taxes

    • Effects:

    • More money stimulates the economy

    • Reductions in taxes increase disposable income

    • Businesses expand and create jobs

    • Result: Increased growth and higher employment

Contractionary Fiscal Policies

  • Objective: Stabilize the economy

    • Strategies: Increase taxes and lower spending

    • Effects:

    • Tax increases slow the economy and reduce inflation

    • Less disposable income

    • Slower business activity leads to lower profits

    • Result: Lower inflation rates and stable growth

Graphical Representations

  • Federal Outlays and Revenues (1940-2015) in $2010

  • Based on data from National Priorities Project, Inc.

America's Financial Overview

  • Budget balance as % of GDP:

  • Trends and forecasts presented by Congressional Budget Office and Office of Management and Budget

  • Involves Mandatory and Discretionary spending categories

Part II - Monetary Policy

Overview of the Federal Reserve System

  • Nature: Independent government agency created in 1913

  • Function: Controls the money supply

  • Structure:

    • 12 Regional Federal Reserve Banks

    • 13,000 Private Member Banks

  • Leadership: Fed Chairman oversees Board of Governors

  • Speed of Monetary Policy:

    • Fast with instantaneous impact on markets and the banking/financial system

    • Unlike fiscal policy, it is not burdened by politics or bureaucracy

The Structure of the Federal Reserve and Banking System

  • Components:

    • Federal Open Market Committee

    • Board of Governors

    • 12 Federal Reserve Banks

    • Commercial Banks

    • Thrift Institutions (Savings & Loan Associations, Mutual Savings Banks, Credit Unions)

    • The Public (Households and Businesses)

Monetary Policy Tools

  1. Reserve Requirements:

    • Defines the minimum amount that banks must hold

  2. Discount Rate:

    • Interest rate charged by Fed to member banks

    • Lower rates encourage borrowing, increasing money supply

    • Higher rates discourage borrowing, decreasing money supply

  3. Open-Market Operations:

    • Buying and selling bonds in the open market

    • Bonds: Certificates issued by government to lenders

    • Purchases increase money supply, sales decrease it

Policy Framework

1. Easy Money Policy

  • Goal: Address unemployment and recession

    • Actions involve buying bonds, lowering reserve ratios, or reducing discount rates

  • Results:

    • Increase in excess reserves

    • Rise in money supply

    • Decrease in interest rates

    • Increased investment spending

    • Aggregate demand rises

    • Real GDP increases by a multiple of the investment rise

2. Tight Money Policy

  • Goal: Combat inflation

    • Actions involve selling bonds, increasing reserve ratios, or raising discount rates

  • Results:

    • Decrease in excess reserves

    • Fall in money supply

    • Increase in interest rates

    • Decreased investment spending

    • Aggregate demand decreases

Interest Rates Overview

  1. Fed Funds Rate:

    • Overnight loans between banks

  2. Discount Rate:

    • Rate from Fed to banks

  3. Prime Rate:

    • Rate banks charge customers with good credit

    • Generally set at Fed funds rate + 3%

Historical Interest Rate Trends

  • Trends of Fed funds and prime interest rates from 1998 to 2010 depicted in statistical graphs

Impact of Monetary Policies on Exchange Rate

1. Easy Money Policy

  • Framework: Lower interest rates

  • Effect: Decreased foreign demand for USD leads to dollar depreciation

  • Result: Net exports increase, aggregate demand increases

2. Tight Money Policy

  • Framework: Higher interest rates

  • Effect: Increased foreign demand for USD leads to dollar appreciation

  • Result: Net exports decrease, aggregate demand decreases

Basic Accounting Principles

  • Balance Principle: Every financial transaction involves equal subtraction and addition in different accounts

  • Example: Paying for groceries leads to a deduction from checking account and an addition to the business's account

Understanding Assets and Liabilities

Assets

  • Definition: Anything owned that adds financial value

  • Examples of Personal Assets:

    • Home

    • Rental properties

    • Checking/Savings accounts

    • Collectibles (cars, jewelry, art, etc.)

Liabilities

  • Definition: Money owed (debt)

  • Calculation of Net Worth:

    • Subtract total liabilities from total assets

  • Example Financial Transactions: All transactions must balance, impacting asset and liability sides

Loans as Assets

  • Connection to Banks:

    • Loans, such as mortgages, are crucial assets for banks as they generate revenue through interest payments.