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Unit 5 econ student
- 1. UNIT #5: Managing the national economy
- 2. The Federal Reserve& MoneyUnit #5
- 3. Money $$$Money: asubstance that functions as a…medium of exchangestandard of valuestore of valueMoney is… AcceptablePortableDurableDivisibleUniformScarce
- 4. Types of Money Wegenerally talk about two kinds of money:Commodity money – money that has some value in trade as a commodityFiat money – money that gains value through government decree
- 5. Measuring the MoneySupplyThe Money Supply is the total amount of money in the economyM1 – the money supply that can be used as cash or easily converted to cash– includes currency (coins & bills), checking accounts, and Traveler’s ChecksM2 – broader measure of money supply and includes M1, savings accounts, and money market funds
- 6. So we havemoney, but how do we have that money transferred between people?= BANKS!!!
- 7. U.S. Banking SystemWeuse a Fractional Bank Reserve System:Requires banks to keep a fraction (called the Reserve Requirement) of their deposits on hand in the form of reservesThe current Reserve Requirement is 10%Banks use the extra money as loans to consumers & businesses that they earn interest off of**In a sense, as banks continuously lend money that is not in reserves they are “creating money”. This lending is increasing the flow of money that ordinarily wouldn’t be able to happen!**
- 8. Bank OperationsBanks functionbased around a few basic actions: accepting deposits and making loansBank Accepts Deposit Bank Puts AwayFrom You Reserve Requirement Bank Uses Remaining Money For Loans
- 9. How much dobanks need to keep on reserves?Reserves = Total Deposit X RR (in % form)--------------------------------------1000 x .20 = 2001000 – 200 = 800--------------------------------------800 x .20 = 160800 – 160 = 640LOANDave’s $640LOANKim’s $800Kim’s $800Pat’s $1000Pat’s $1000 Pat’s $1000
- 10. Examples – CalculatingReservesUse this formula:Amount of Reserves = Total Deposit X RR (in % form)Mr. Allgyer’s bank gets a deposit of $20,000. The reserve requirement is 20%. How much does he need to keep in reserves?Mr. Allgyer’s bank now gets a deposit of $10,000. The reserve requirement is 15%. How much does he have to lend out?
- 11. How much totalmoney do banks create?Because each loan decreases in size, we will eventually run out of money to loan based on one initial deposit. We can figure out where it caps out by using the equation:Amount of Money Created = Total Deposit / RR (in % form)Ex) Total Deposit: $1000 Reserve Requirement: 20% Money Supply: $5000
- 12. Example – MoneyCreationUse this formula:Amount of Money Created = Total Deposit / RR (in % form)Mr. Allgyer’s bank gets a deposit of $3000 and the reserve requirement is 10%. How much money will be put into the money supply through loans/deposits?
- 13. The Federal ReserveSystemThe Fed is the central bank of the U.S.Its goal is to keep the entire banking system stable and healthyTheir responsibilities include:Holding reservesProviding cash & loans to banksClearing checksControl the nation’s money supply (they set the Reserve Requirement!)Issues Federal Reserve Notes (our paper currency)
- 14. Controlling the EconomySchoolof Thought #1: MONETARISM Belief that changes in the money supply can play an important role in controlling the economyPushed by economist Milton FriedmanHe believed that it was the Fed’s job to control the money supply to influence the economy!
- 15. The Federal ReserveSystemEcon Alive pages 282-288Complete Section III (A-E)
- 16. “The Fed” =CENTRAL BANK OF THE U.S.Primary method of managing the economy is through monetary policycentral bank policy aimed at regulating the amount of money in circulation and interest ratesGoal of policy is to allow the economy to grow, achieve full employment, and keep price stableCreated in 1913 by CongressSLIDE 1
- 17. Structure of FedChairmanof Board & FOMC – Ben S. BernankeBoard of GovernorsBoard of 7 Governors appointed by President for 14-year terms (1 vacancy/2 years)Purpose is to supervise banking system & control direction of monetary policyChairman is appointed by President for 4 year term & is spokesperson for FedFederal Open Market Committee (FOMC)Made up of 7 members of Board of Gov., 5 district bank presidents (1 is always the Pres. Of NY Fed)Meets 8 times a year to determine changes to monetary policyFed Reserve District Banks12 Districts with a Federal Reserve Bank in each one
- 18. Policies followed byFedEasy Money Policy (Expansionary)Fed expands the money supply trying to cause cheaper lending to stimulate economic growthInterest rates lower but too much easy money policy leads to INFLATIONTight Money Policy (Contractionary)Fed shrinks the money supply trying to cause lending to be more expensive to slow the economyInterest rates rise but too much tight money policy leads to a RECESSION
- 19. The Fed carriesout monetary policy by using these 3 tools…1. Reserve Requirement2. Discount Rates3. Open Market Operations
- 20. Tools of theFedOpen Market Operations DEFN: buying & selling of gov’t securities in bond marketBuy Securities = More $ Sell Securities = Less $Most-Used ToolReserve RequirementsDEFN: amount of deposit bank keeps in reservesHigh RR = Less $ Low RR = More $Least-Used ToolDiscount RatesDEFN: Interest Rates on loans the Fed gives to banksHigh DR = Less $ Low DR = More $Rarely-Used Tool
- 21. Targeting the FederalFunds RateFed Funds Rate – interest rate that banks charge each other for short-term loansBanks set this rate, so this is NOT a monetary policy toolHOWEVER, the Fed sets a target rate based on its view of the economy & uses OMO to nudge the rate towards the target!
- 23. UNIT #5 FedREVIEW: Define monetary policy in your own words. If the Fed wanted to increase the money supply using the discount rate, what would they do? Would the Fed be attempting to stimulate or slow down the economy? If the Fed wanted to decrease the money supply using reserve requirement, what would they do? What would happen to interest rates? If the Fed wanted to increase the money supply using open market operations, what would they do? Would this be considered easy or tight money policy? What is the relationship between interest rates and the amount of credit demanded?
- 24. Aggregate supply &demandAGGREGATE SUPPLY & DEMAND
- 25.
- 26. The basics…Aggregate supply= total supply of goods and services produced in the nation’s economyAggregate demand = total demand for goods and services in the nation’s economyMacroeconomic Equilibrium = when aggregate demand equals aggregate supply
- 27. Review of Demand-Sidevs. Supply SideWhat do demand-siders want?What do supply siders want?How do they want us to achieve those effects?
- 28. Supply & Demand’sInfluence on Monetary PolicyHow does the Fed stimulate the economy?
- 29. CI’s & CO’sWhatis monetary policy? How would you stimulate the economy right now using ONE TOOL of monetary policy (discount rate, reserve requirement, or open market operations)? How could the government stimulate or slow down the economy? List anything you know about fiscal policy (their way of managing the economy). Describe a major similarity and difference between monetary & fiscal policy.How do demand-side and supply-side policies differ?How are aggregate supply & demand different from the supply & demand that we’ve already covered? Draw an aggregate supply & demand graph, show the effect of demand-side policies on the graph, and explain the two ways in which Keynes and demand-siders argued that they could achieve this effect (list the two tools!). Describe one economic cost & one social cost of economic instability.What is deficit spending, and why does the government do this?Define transfer payments in your own words. Also, provide an example of a transfer payment. Some costs of economic instability are stagflation, a high misery index, a large GDP gap, wasted resources, political instability, and increasing crime. Choose two of these & describe them!Scenario – Taxes on all businesses are increased. Draw what happens to aggregate supply.What are transfer payments?Describe the difference between the 3 major taxes: regressive, proportional, and progressive. Also, give a real life example of one of the taxes. By the government keeping both individual income taxes and business income taxes high, how will this impact the economy? Also, what type of fiscal policy is this: expansionary or contractionary?
- 30. Fiscal PolicyRead pages279-282 & complete Section on “Government Influence on Economy” (A – C)
- 31. What is fiscalpolicy?the use of government spending and taxing to influence economic activityGoals are economic growth, full employment, & stable pricesExpansionary Fiscal Policy – Goal is to stimulate economic activityIncrease spending & Lower taxesContractionary Fiscal PolicyGoal is to slow down economic activityDecrease spending & Increase taxes
- 32. Theories on theGovernment Role in the EconomyDEMAND-SIDE EconomicsSUPPLY-SIDE EconomicsPolicies designed to stimulate aggregate demand (nationwide consumption) by cutting individual income taxes and increasing government spendingPut forth by Keynes in 1936 (called Keynesian economics)Idea that GOV’T HAS BIGGER ROLE IN ECONOMYpolicies designed to stimulate aggregate supply (nationwide production) by lowering corporate income taxes and the individual income tax on high-income taxpayersIdea that GOV’T HAS SMALLER ROLE IN ECONOMY
- 33. Impact of GovernmentSpendingThe government’s spending has a magnified effect on the economy due to…the “multiplier effect” – each dollar spent encourages more spendingOption 1 – spend more = stimulate the economyOption 2 – spend less = slow the economyGovernment uses “automatic stabilizers” to manage the economyThese stabilizers counter the fluctuations of the business cycleExamples include:transfer payments (payments for which the government receives nothing in return) such as unemployment benefits, food stamps, welfareTax bracketsThey work by increasing or decreasing aggregate demand
- 34. TaxesTaxes are mandatorypayments to the government
- 35. Two Tax PrinciplesConditions:Thosewho benefit from gov’t services should be the ones who pay for themPeople should pay taxes in proportion to the amount of services or benefits they receivePeople should be taxed according to their ability to pay, regardless of the benefits they receive Benefit Principle Ability-to-Pay Principle
- 36. Three Types ofTaxesProportional –same % rate of taxation on everyone, regardless of incomeProgressive –higher % of taxation on persons with higher incomesRegressive –higher % of taxation on lower incomes than higher
- 37. Specific TaxesSales Tax= taxes paid on purchasesVaries by state by amount and which items are actually taxedTend to be a Regressive taxFICA (Federal Insurance Contributions Act) = federal tax levied for SS & MedicareMedicare is federal healthcare program available to all senior citizens regardless of incomeExample of a Proportional Tax (1.45% of all earnings)Social Security is a federal retirement fund SS is capped tax that doesn’t exceed 6.2% of wages & salaries up to $106,800Example of a Proportional tax (up to $106,800) but then Regressive afterwardsFederal Individual Income Tax = tax on people’s earnings is paid through a payroll’s withholding system example of Progressive tax
- 38. Specific TaxesExcise Tax=taxes paid on products the government wants to regulateExamples include cigarettes, alcohol, & gasolineTend to be a Regressive taxProperty Tax= taxes for land & buildingsProperty taxes are a significant source of revenue for public schoolsExample of a Proportional Tax based on the assessed value of propertyOther Taxes – Luxury, Estate, Corporate Income, Unemployment
- 41. Impact of Government Spending & Deficit Spending
- 42. Government SpendingGovernment revenuescome from:Individual income tax, payroll taxes (ex. FICA), corporate income taxes, and excise taxesGovernment spends their money on:1. Mandatory spending – Fixed by lawmust pay interest on national debt & on entitlements/transfer payments (ex. Social security, welfare, & medicare)2. Discretionary spending – Can be raised or lowered as Congress sees fitExamples are education, defense, health care, foreign aid, etc.
- 43. Deficit Spending YOUMUST distinguish between debt & deficit!A deficit is not having enough revenues to meet gov’t spending in one yearDeficit 2006 + Deficit 2007 + Deficit 2008 = DEBT So national debt is the accumulation of all deficits (total money owed from borrowing) over time!Deficit Spending is when the government spends more money than it collects in revenue
- 47. Deficit SpendingTHE AMERICANGOV’T LOVES TO DEFICIT SPEND!! But why???spending more may help to stimulate the economywe need to protect ourselveswe have to do it (mandatory spending – baby boomers hitting the retirement age)
- 48. Effects of DeficitSpendingAdds to national debtInflation can occur!Unease about foreign-owned debtCitizens become discouragedWorried about the tax burden on future citizensFeel like their money is wastedFear of Government BankruptcyHow does uncertainty hurt the economy?Purchasing power transfer from private sector (private individuals/businesses) to public sector (levels of government) because the government taxes us more so they can spend!CROWDING OUT EFFECT!!When the gov’t borrowing drives interest rates up so high that people are no longer willing to borrow money to invest in businesses, to buy products on credit, etc.
Editor's Notes
- #6 Most common measure of money supply is M1 – currency (coins & paper money), checking accounts (demand deposits), & T-Checks (buy checks to use as cash for money ready for spending) ALL ASSETS THAT CAN BE USED OR CONVERTED TO CASH QUICKLY M2 is broader classification of money – money not as easily accessible like savings accounts/funds (near-money)Credit cards are not moneyWhy look at money supply? – forecast inflation, demand, investment, business, etc. (greatly influences what happens in the economy)
- #10 With every deposit, there is an increase in the lending power of the bankThus, the monetary value of one deposit will have lending power well beyond its value
- #11 #1 Answer = $4,000#2 Answer = $1,500
- #13 Answer = $30,000
- #14 Holding reserves – holds the reserve requirement for banksProviding cash (when funds are low due to withdrawals) & loans (discount rate)Clearing checks – transfer funds from one account to another (from your account to the store’s account you bought something from)
- #15 Critic of Keynes who argued that the Great Depression was not because of a lack of demand, it was a drop in the money supply between 1929 & 1933 as banks failed and wiped out the accounts of depositors. As $ supply shrank people stopped spending = falling prices, rising unemployment & business failure, & declining incomesBelieve we should used monetary policy or in this case the Fed should have expanded the $$$ supply during depression so with more money in circulation spending would have picked up & expansion would have ensued
- #19 GOAL IS TO INCREASE MONEY SUPPLY FAST ENOUGH TO KEEP UP WITH GROWTH BUT NO FASTER!Easy money – consumers spend too much, increase in demand causes demand-pull inflationTight money – deflation results with low levels of investment & spending
- #22 Required to get quick loans if they don’t have enough reservesWhy this rate? = easiest rate to change using OMO, affects interest rates for mortgages/credit cards/savings accounts/bonds
- #23 The FOMC Policy Decision"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability."Again, the FOMC opted for no change in the target federal funds rate, essentially repeating the March policy statement. 'The fed funds rate can't be used effectively to help the member banks, who borrow reserves at the fed funds rate from other member banks. With the target so low, monetary policy, especially open market operations, is not an effective stimulatory tool.
- #27 Economic performance can be illustrated through the concepts of aggregate supply and aggregate demand. LAW OF SUPPLY - It is upward-sloping because at higher prices firms have an incentive to produce more, and at lower prices they are likely to produce less.LAW OF DEMAND - It is downward-sloping because at higher prices, consumers, firms, government, and foreign customers are less willing to buy, while they will likely buy more at lower prices. Shifts in the aggregate supply and aggregate demand curves can illustrate changes in the performance of our economy. If consumer confidence in the economy falls and people reduce their spending, aggregate demand can fall, reducing real output and prices and possibly dropping the country into a recession. However, if the money supply is too large, excessive consumer demand can push up the aggregate demand, raising real output and prices and possibly pushing the country into serious inflation.
- #28 Keynes recommends that,during periods of recession, Congress should increase government spending in order to “prime the pump” of the economy. At the same time, he recommends, Congress should decrease taxes in order to give households more disposable income with which they can buy more products. Through both methods of fiscal policy, the increase in aggregate demand stimulates firms to increase production, hire workers, and increase household incomes to enable them to buy more.Economists generally look to annual goals of GDP growth of 2.5-3 percent, an inflation rate of 3-4 percent, and an unemployment rate of approximately 5 percent for stable economic growth. However, our economy generally follows an economic cycle of recession and expansion every few years. As John Maynard Keynes argued in his 1936 book General Theory of Employment, Interest, and Money, nations need not wait for potential economic problems to correct themselves. He advocated that government take an active role in resolving economic issues through the use of two policies: fiscal policy and monetary policy. (classical theory says that market/economy will correct itself)
- #29 The demand for money consists of consumers borrowing for such items as cars and homes, firms borrowing for such items as factories and equipment, and the government borrowing to finance the national debt. The supply of money is set by the Federal Reserve Board of Governors, the central banking system for the United States. The supply and demand for money determine the interest rate that must be paid for the use of borrowed money. So if the Federal Reserve increases the money supply, interest rates will fall, making it less expensive to borrow money. In that case, those wishing to borrow money will be more likely to do so-- and be more likely to spend that money on products. If the Federal Reserve reduces the money supply, interest rates will rise, so less will be borrowed and spent (because of the higher cost of borrowing).
- #32 Expansionary - economy is sliding into recession, need to stimulate economyExample of expansionary – issue stimulus checks/tax rebates, increase gov’t purchases of goods/servicesContractionary – economy is overheating, buyers are demanding more than what can be produced, prices rising, etc.
- #33 Demand-Side Policies - believe best way to deal with sluggish economy is to stimulate demand by cutting taxes (consumers buy more) & spending more (stimulus check) which gets businesses going again-business/investment sector is cause of instability in OE model, ended up causing magnified impact on other spending-government can step in to offset changes in investment sector spending (ex. Lower taxes and enact other measures to encourage businesses & consumers to spend more)-major example of this policy is deficit spending-when economy recovers, tax collections rise, and gov’t would have surplus to pay back debt-idea is that gov’t spends to make up for I sector ‘s lack of spending but then should stop when I sector recovers-use automatic stabilizers (programs that trigger benefits if changes in economy threaten people’s incomes) such as unemployment insurance & federal entitlement programs (welfare, pensions, medicare, Social Security)Supply-Side Policies- stimulate output by cutting taxes, as businesses & investors have more money then supply will increase, spurring economy (leads to more income to workers then more demand)GOV’T MUST CONSIDER BOTH APPROACHES WHEN DEVELOPING THEIR ECONOMIC POLICY!!!
- #34 1,000 spent by gov’t to provide income to teen for making trails in public parkTeen saves $300 and spends $700 on bicycleShop owner saves $200 and spends $500 on car repairsMechanic saves $100 and spend $400 on a painter to paint his fenceAlso SAVINGS turns into loans!Stabilizers during bad economyDemand drops and businesses lay off workers in recessionWorkers earnings decline so lower tax bracket and slowed business does the sameWorkers start getting unemployment benefits, welfare payments, and food stamps to encourage spending and to help improve economy
- #36 Why?– societies not always able to measure benefits & persons with higher incomes suffer less discomfort paying taxes than persons with lower incomesAtPay – Income tax, luxury itemsBenefit – people who drive should pay for highway system (tolls & gas taxes)
- #37 Progressive operates under ability-to-pay principle & puts greater tax burden on the wealthy than on the poor, is this fair though? (does it punish those who work, save, & invest?
- #38 Federal Gov’t receives most revenues from individual income taxes, corporate income taxes, & SS taxesStates & Fed Gov’t issue progressive income taxesSales – proportional that turns regressive but to limit the progressive effects governments do not tax necessities such as food & medicineSocial Security – tax on wages a company pays its employees (company pays half & employee pays half for total of 12.4%)Medicare – split for company & employee for total of 2.9%, no cap which makes it a true proportional taxCorporate Income tax – applied to profits of corporations, they are progressiveUnemployment tax – state payroll tax used to assist workers who lose their jobsProperty tax – for land, buildings, & sometimes personal property like cars and boats (they are proportional taxes on assessed value) – these pay for public schoolsExcise – levied on goods/services that the gov’t wants to regulate (generally regressive), ex. Such as cigarettes & alcohol called sin taxesLuxury taxes – levied on sale of luxury goods like fur goat or private jet, progressive b/c consumption increases as income increasesEstate tax (fed gov’t) & inheritance tax (state gov’t) – on assets left to heirs if someone dies, are progressive because larger estates are taxed at a higher rateBoth the federal and state governments levy excise taxes on goods such as alcohol, motor fuel, and tobacco products. Even though federal excise taxes are geographically uniform, state excise taxes vary considerably. However, taxation constitutes a substantial proportion of the retail prices on alcohol and tobacco products.Local governments may also impose an excise tax. For example, the city of Anchorage, Alaska charges a cigarette tax of $1.30 per pack, which is on top of the federal excise tax and the state excise tax.Investopedia explains Regressive TaxSome examples include gas tax and cigarette tax. For example, if a person has $10 of income and must pay $1 of tax on a package of cigarettes, this represents 10% of the person's income. However, if the person has $20 of income, this $1 tax only represents 5% of that person's income.Sales taxes that apply to essentials are generally considered to be regressive as well because expenses for food, clothing and shelter tend to make up a higher percentage of a lower income consumer's overall budget. In this case, even though the tax may be uniform (such as 7% sales tax), lower income consumers are more affected by it because they are less able to afford it.
- #39 Federal Gov’t receives most revenues from individual income taxes, corporate income taxes, & SS taxesStates & Fed Gov’t issue progressive income taxesSales – proportional that turns regressive but to limit the progressive effects governments do not tax necessities such as food & medicineSocial Security – tax on wages a company pays its employees (company pays half & employee pays half for total of 12.4%)Medicare – split for company & employee for total of 2.9%, no cap which makes it a true proportional taxCorporate Income tax – applied to profits of corporations, they are progressiveUnemployment tax – state payroll tax used to assist workers who lose their jobsProperty tax – for land, buildings, & sometimes personal property like cars and boats (they are proportional taxes on assessed value) – these pay for public schoolsExcise – levied on goods/services that the gov’t wants to regulate (generally regressive), ex. Such as cigarettes & alcohol called sin taxesLuxury taxes – levied on sale of luxury goods like fur goat or private jet, progressive b/c consumption increases as income increasesEstate tax (fed gov’t) & inheritance tax (state gov’t) – on assets left to heirs if someone dies, are progressive because larger estates are taxed at a higher rateBoth the federal and state governments levy excise taxes on goods such as alcohol, motor fuel, and tobacco products. Even though federal excise taxes are geographically uniform, state excise taxes vary considerably. However, taxation constitutes a substantial proportion of the retail prices on alcohol and tobacco products.Investopedia explains Regressive TaxSome examples include gas tax and cigarette tax. For example, if a person has $10 of income and must pay $1 of tax on a package of cigarettes, this represents 10% of the person's income. However, if the person has $20 of income, this $1 tax only represents 5% of that person's income.Sales taxes that apply to essentials are generally considered to be regressive as well because expenses for food, clothing and shelter tend to make up a higher percentage of a lower income consumer's overall budget. In this case, even though the tax may be uniform (such as 7% sales tax), lower income consumers are more affected by it because they are less able to afford it.
- #40 Here's what's going on:In 2007 and 2008, US government tax revenues averaged about $633.15 billion per quarter. For the first quarter of 2009, however, the numbers just in tell us that tax receipts totaled only about $442.39 billion – a decline of 30%. Looking to confirm the trend, we compared the data for April – typically the big kahuna of tax collection months – to the 2007-2008 average, and found that individual income taxes this year were down more than 40%. The situation is even worse for corporate income taxes, which were down a stunning 67%. f the shortfall in individual and corporate tax revenue persists – and we expect it will – then the deep hole the government is already digging for itself will be that much deeper. Using the government's own expense projections, the revenue shortfall, even if it doesn't worsen further, would push the fiscal 2009 budget deficit up to about $1.958 trillion. Case in point, in January the government projected a $1.2 trillion deficit for fiscal year 2009...in March, just three months later, they upped the projection to $1.8 trillion. That $600 billion "adjustment" alone totaled more than any full-year budget deficit in the nation's history.
- #43 payments to disadvantaged like SS, welfare, unemployment, & aid to handicap), include payment for highways to states (grant-in-aid) or subsidies to individuals or businesses to protect/promote economic activity (ex. Farmers)
- #44 Debt is money owed while Deficit is spending more than you take in (debts are a result of deficit spending & debts are accumulated over years of time) If we add up all federal bonds & other debts, we have a measure of federal debt (total amount borrowed from investors to finance deficit spending)
- #46 http://www.politicsrealm.com/images/obama-deficit.jpg
- #47 That's because the Treasury is buying toxic investments (mortgage bonds, credit-card loans and so on) and putting them on the books with a higher value than the market is willing to assign.While that makes the budget deficit appear smaller, it doesn't negate the fact that the government still must borrow the money needed to buy the toxic paper in the first place. The additional revenue shortfall means they have to raise that much more money. Based on the struggle they had pushing the $14 billion in long-term notes at the latest auction, it becomes increasingly apparent that when push comes to shove, the only way the government is going to come up with the money needed to meet its aggressive spending is to print it up. We also believe that inflation could start setting in as early as Q3 of 2009 and will accelerate sharply by 2010. Treasury Rates will start climbing and the era of cheap money will end, making it harder for overleveraged consumers, businesses, and governments to service their debt.
- #48 In Keynes model, sometimes gov’t has to step in & stimulate demand or supply therefore making expenditures is necessary -we can always borrow more & lowering deficits lowers the demand for money (raise interest rates)
- #49 -deficit adds to the national debt-countries will eventually stop lending to the U.S. & stop trusting U.S. (maybe our bonds will be downgraded to less than AAA rating)-balanced budget is bad during recession b/c it will get worse if we cut spending & transfer paymentsalso bad during boom to cut taxes & increasing spending will cause inflation-transfer of purchasing power from private to public (if gov’t wants to increase military spending then they will raise taxes therefore decreasing purchasing power of private individuals)-can change distribution of income (federal tax structure favors some classes - ex. If gov’t borrows from rich then taxes paid to make interest payments go to rich & middle class suffer)-crowding out effect = when gov’t runs deficit they need to sell bonds or somehow get money, because they are increasing demand for money interest rates rise & force private borrowers to either pay higher rates or stay out of the marketA WAY TO COMBAT CROWDING OUT - monetize the debt? Create enough extra money to offset deficit spending (increase money supply) to keep interest rates downAs gov’t borrows more, interest rates rise because credit is being competed for therefore interest rates can riseGov’t increases money supply (therefore increasing credit) to keep interest rates stable)-individual incentives – if people believe the gov’t is spending freely therefore they are taxed more, then people lose initiatives to work harder, save, and invest