Keeping an Eye on the Economy: Fiscal vs. Monetary Policy
The economy is very
complex; many factors can influence the strength or weakness of a country’s
economy. Externalities (hurricanes, bad
weather, pollution), fiscal policy
(taxing, spending), and monetary policy
(interest rates and amount of money in circulation) can all have an impact on
the overall economy. A business cycle
refers to economy-wide fluctuations
in production, trade and economic activity in general over several months or
years in an economy organized on free-enterprise principles
Fiscal
Policy involves
taxing and spending. The President along with Congress set the fiscal policy for the country.
It is very popular for politicians to cut taxes and increase
spending. However resources are limited
and not all programs can be funded, nor can all taxes be cut. When taxes are cut or spending is increased,
money is pumped into the economy. Consumers have more money to spend,
which increases demand, it in turn increases production, employment and further
spending. Producers offer more goods
and services to the people. Raising taxes and cutting spending slows the
economy by taking money out of the economy.
Fiscal policy may take a long
time to enact, but once in place, it is felt immediately in the economy. Because fiscal
policy is set by elected officials, it can often be influenced by political
pressures.
Monetary
Policy involves the
actual money in circulation, the value, and cost of that money. The Federal
Reserve (FED) is in charge of
the nation’s monetary policy. The FED
is an autonomous (self-ruling and regulating) body. However, there is some Congressional
oversight of the FED. The chairman of the FED is selected by the President, and he must make regular reports
to Congress on the health of the economy.
The tools of the Federal Reserve are interest rates, reserve requirements, and open
market operations (bonds and securities).
The FED looks at the many
economic indicators to set its policy, and meets monthly to review the health
of the economy. The FED’s goal is 3% economic growth.
If the economy is growing too fast, the FED pulls money out by raising interest
rates, raising reserve requirements
(the amount of money banks must keep on hand), or by selling bonds and securities. If the FED
wants to speed up the economy it lowers interest
rates, lowers reserve requirements
and buys bonds and securities. Monetary policy making happens quickly,
but the effects take a while to trickle down into the economy. However, monetary
policy decisions are less likely to be influenced by politics.
The Economic Indicators
that both policy makers are concerned with include:
Ø
Gross Domestic Product (GDP) – the value of all goods and services
produced within a nation’s borders.
Ø
Consumer Price Index (CPI) – measures the percentage increase in
the cost of durable goods.
Ø
Inflation Rate – using the CPI the rate of inflation
is measured, inflation is the increase in the cost of goods and services
Ø
Unemployment – the number of people who do not have
a job and are actively seeking one.
Economists chart the
overall health of the economy by evaluating the economic indicators above. This chart is known as the business cycle. An upswing in the economy, or expansion, is
characterized by growth in GDP and
overall prosperity. When the economy
grows too quickly prices can rise causing inflation
and an increase in the CPI. An increase in prices often will cause a
decrease in demand, which will in turn cause unemployment to rise causing an economic contraction. A contraction (no or negative growth) of the
economy for 2 or more consecutive quarters is known as a recession. A prolonged
contraction is known as a depression. The economy is a cycle so what goes up will
eventually come down and then cycle back up, this cycling back up is known as a
recovery, the bottom of the business cycle is known as a trough.
Summarizing Fiscal and Monetary Policy
Part I. Directions: Use the previous
reading on Fiscal and Monetary Policy to
complete the table below.
FISCAL POLICY
|
CHARACTERISTIC
|
MONETARY POLICY
|
Definition
|
||
Who’s responsible
for developing and implementing it?
|
||
What tools are
used for implementing it?
|
||
How long does it
take to be effective?
|
||
How is it
influenced?
|
Part
II. Directions:
Read each description below and decide if it is Fiscal Policy or
Monetary Policy. Then write the correct
phrase in the space provided.
1.
__________________
The President encourages Congress to pass a tax cut.
2.
__________________
The FED raises interest rates to slow the economy.
3.
__________________
Congress cuts spending.
4.
__________________
The FED raises the reserve requirement for banks.
5.
__________________ FDR created a “New Deal” for the economy
which included job creation
through public works.
6.
__________________
The FED buys bonds to increase the money supply.
7.
__________________
Congress passes new tax incentives for businesses.
END OF ASSIGNMENT
Name: Date:
Directions: Explain the following types of FEDERAL taxes.
Make sure you DEFINE the type of tax and give an example for each, where
applicable. Use your book ONLY, on pages 449 to 451. You may write on this, it
is yours to keep.
1.
Individual income tax
2.
Corporation income tax
3.
Social insurance taxes:
4.
Excise taxes
5.
Estate and gift taxes
6.
Custom duties
Name: Date:
Directions: Use pages 454-456 to complete the following hand-out.
Directions: Use pages 454-456 to complete the following hand-out.
1.
For what three reasons does the government
borrow money
a.
b.
c.
2.
Explain the process by which the government
borrows money.
3.
What government corporation generates nontax
revenue for the government?
4.
What has been the trend of public debt over the
past 20 years?
Terms: Define the following key terms
1.
Interest
2.
Deficit
3.
Surplus
4.
Public debt
Using Fiscal Policy
Directions:
Use the table below to answer the questions that follow.
How the Government May Use
Fiscal Policy
|
|
To Encourage Growth
|
To Encourage Stabilization
|
Increased Spending,
Lower Taxes
·
The government spends more money to stimulate growth in
the economy.
·
The government cuts taxes to increase individual
spending and business output
·
Businesses expand and create jobs.
|
Increased Taxes,
Lower Spending
·
The government increases taxes to slow a rapidly
growing economy and widespread price increases.
·
Individuals spend less and businesses make smaller
profits
·
Lower business activity and decreased spending lead to
lower prices.
|
Result
Increased
growth in the economy and higher employment
|
Result
Low
inflation rates and stable growth in the economy.
|
Directions: Read each statement, determine whether it is true
or false, and write your answer in the
space provided.
_____
1. When the government cuts taxes it
stabilizes the economy.
_____
2. When the government spends money it
stimulates the economy.
_____
3. Business expansion occurs when the
government spends money.
_____
4. Decreasing spending lowers prices.
_____
5. Increasing taxes lowers inflation
rates and stabilizes the economy.
_____
6. Cutting taxes causes economic growth.
_____
7. Government tax cuts help increase
individual and business spending.
_____
8. When taxes are raised individuals
spend less.
_____
9. When taxes are raised businesses make
higher profits.
END OF ASSIGNMENT
Unit 5A: Financial Policy Cloze Notes
Terms
ž Opportunity Costs: the loss of potential gain from
other alternatives when one alternative is chosen
ž The opportunity cost of something is
simply the highest valued alternative that must be foregone when a choice is
made.
ž Revenue: money that is
ž Expenditure: money that is
ž Taxes: a charge imposed upon an individual (tax payer)
by a government agency for the purpose of raising money (revenue)
The power to
tax
ž The federal government can tax the
state and local governments. However, there are implied limitations on
the power
— 1. State/local governments cannot be
taxed for the exercise of their duties
— 2. Federal government may tax
non-governmental state and local activities such as sale of alcohol or
cigarettes
Terms
ž Gross income: an individual’s or
business’s gains from all sources. Gross income is the for determining Federal and state income
tax.
ž Net income: an individual's or
business’s income cost
of goods sold, expenses and taxes for an accounting period.
— It is the end amount of money made
(PROFIT).
ž Government makes a large portion of
revenue from interest collected from borrowed money (a loan)
ž Interest is a for borrowed money
ž Sources of interest government
collects as “
revenue”
— Loans made by certain federal
agencies
— Canal tolls
— Passport fees
— Copyrights, patents, and trademarks
Spending and the Budget
ž Federal Reserve System: is the central system
of the United States.
ž Fiscal policy is the use of government collection ( ) and ( )
to influence the economy
ž Federal Budget: Detailed financial budget
containing estimates of federal and during the coming fiscal year
Monetary Policy
ž Government controls the
of ,
(already in circulation) often targeting a rate of interest for the
purpose of promoting economic growth and stability.
Economic Growth
ž Economic growth is the increase in the of
the goods and services produced by an economy over time.
ž Inflation is a persistent in the general level of goods and services in
an economy over a period of time
ž Recession is a general in economic activity
ž Depression is a sustained, long-term in economic activity in one or more economies
ž Economic Recovery: A period of increasing activity signaling the end of a recession
Supply and Demand
ž Supply and demand is an economic
model of
determination in a market economy. It concludes that the unit
price for a particular good will vary until it settles at a point
where the quantity demanded by consumers (at current price) will equal the
quantity supplied by producers (at current price).
ž A trade-off (or
tradeoff) is a situation that involves one quality or aspect of something in return
for another quality or aspect
ž Scarcity is the fundamental economic
problem of having seemingly human wants and needs in a world of resources
END
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