Fiscal and Monetary Policy Overview

Fiscal and Monetary Policy Notes

• Fiscal Policy Tools: Government spending and taxes

• Fiscal Policy to Increase GDP/Economy: Government spending boosts demand; raising income tax rates has the least negative impact on GDP

• Fiscal Policy to Slow Inflation/Recession: Collecting more taxes reduces spending, decreasing aggregate demand

• Aggregate Demand and Expansionary Fiscal Policy: Increases in aggregate demand

• Tax Structures:

  • Regressive: Taxes have a greater impact on lower-income individuals than wealthy individuals. An example is a sales tax
  • Proportional: Equal impact across all income levels. Taxes collected as a percentage of the value of the asset, an example is property tax.

• Ways to Fix Budget Deficits:

  • Issuing bonds
  • Increasing income
  • Reducing expenses
  • Increasing taxes

• Keynesian Economics: Advocates for active government intervention in the economy.

• Economic Model Examples of Periods using Keynesian Economics: The Great Depression

• Economic Stabilizers (Two Types):

  • Automatic Stabilizers: Built-in mechanisms within the tax system and spending system that adjust to economic conditions; examples include progressive income tax, unemployment insurance, welfare programs.
  • Discretionary Fiscal Policy: Deliberate government actions to influence the economy; examples include stimulus packages, tax cuts, government spending cuts.

• What is "the Fed"? The Federal Reserve, the central bank of the United States

• What Created the Fed? A severe panic in 1907, resulting in bank runs, prompted Congress to create the Federal Reserve.

• How Many Federal Reserve Bank Districts Are There in the U.S.? Twelve

• Three Main Jobs of the Fed:

  • Conducting monetary policy
  • Supervising banks
  • Maintaining financial system stability

• Increasing Money Supply: Lower interest rates lead to more investment and consumption, stimulating the economy, making people feel wealthier, and spurring spending

• Decreasing Money Supply: Reduction in the money supply leads to an increase in interest rates and decreased consumer spending and economic activity.

• Monetary Policy Tools to Grow the Economy:

  • Open Market Operations: Buying government bonds to increase money supply and lower interest rates stimulating borrowing and spending
  • Discount Rate: Lowering the discount rate encourages banks to borrow more and thus lend more to the public, increasing available money and boosting economic activity.

• Monetary Policy Tools to Slow the Economy:

  • Open Market Operations: Selling government bonds to decrease the money supply and increase interest rates, discouraging borrowing and spending, potentially leading to reduced economic growth
  • Discount Rate: Raising the discount rate makes borrowing more expensive for banks, reducing their ability to lend, decreasing money supply and leading to slowing economic growth.

• Expansionary Policy: Implemented to stimulate the economy, increase economic growth, and enhance employment rates.

• Contractionary Policy: Utilized to slow down an economy's growth and combat inflationary pressures.

• Fiscal Policy: The use of government spending and taxation to manage and influence the economy

• Taxes: Mandatory contributions levied on individuals or corporations to fund government activities and public services

• Government Spending: Money spent by the government on goods and services like education, healthcare, and defense.

• Mandatory Spending: Fixed spending on Social Security, Medicare, and other programs

• Discretionary Spending: Flexible spending on programs that are changed annually; examples include education, defense and transportation.

• Budget Surplus: Income or revenue exceeds expenditures

• Budget Deficit: Spending exceeds income or revenue

• Balanced Budget: Revenue is equal to expenditures.

• Monetary Policy: The Federal Reserve's actions to influence the economy through interest rates and money supply

• Money Supply: The total amount of cash and cash equivalents in circulation

• Government Securities: Bonds issued by the government to finance operations (also called Treasury Bills)

• Reserve Requirement: The amount of cash that financial institutions must hold in reserve, in relation to deposits made by their customers.

• Discount Rate: The interest rate at which commercial banks can borrow from the central bank (the Fed).