15Economic Policy

Conditions Required for a Market Economy• Government has a role to play in a market economy:– Ensure law and order– Secure property rights– Enforce contracts

• There is a need for public policies – laws, rules, statutes, or edicts that express the government’s goals for rewards and punishments to promote their attainment

Public Goods and Externalities

• Public goods are services that in most cases are not provided by the free market

• Examples:– Infrastructure– Education– Military

• Externalities are secondary impacts resulting from market exchanges

Creating a Labor Force and Promoting Competition• Governments have an interest in maximizing the productivity of their labor force

• Monopolies threaten the proper function of free markets

Market Failures and Collective Responses• Some market problems:– Unequal information– Bubbles – Speculative buying drives the price of major commodities (like real estate) to levels far exceeding their intrinsic value

– Externalities – The difference between the private and social cost of economic behavior

• We want government to correct for these problems with carrots and sticks

Clicker Question

Which of the following is NOT considered to be a role for government in ensuring the proper function of markets?

A.Creating monopoliesB.Creating law and orderC.Securing property rightsD.Enforcing contracts

Goals of Economic Policy• Market stability– Law and order– Ensuring competition– Consistent regulatory structure

• Promoting prosperity as measured by– Economic growth– Income and employment– Low Inflation

Changes in Real Gross Domestic Product, 1960–2010

Full Employment

• During the Great Depression, the federal government assumed the responsibility for job creation

• Keynesian economics emerged as the dominant economic theory to restore economic growth and employment

Tools for Promoting Economic Growth• The Federal Reserve Bank can promote economic growth by lowering interest rates

• Regulatory agencies like the Securities and Exchange Commission (SEC) promote consumer confidence

• Government investment in science and technology can lead to long-term innovation

Tools For Economic Growth• Subsidies – A government grant of cash or other valuable commodities, such as land, to an individual or organization; used to promote activities desired by the government to reward political support, or to buy off political opposition

• Loans/grants• Tax Breaks

Clicker Question

The Federal Reserve Bank can regulate economic growth by:

A.providing tax breaks to business owners.B.increasing or decreasing interest rates.C.providing loans to business owners.D.regulating insider trading.

Protecting Employers and Consumers

• Government has a role to play in managing relations between capital and labor

• Many government agencies exist to protect consumers from harm

Tools of Economic Policy• Monetary policy regulates the economy through increasing or limiting the availability of credit

• The Federal Reserve Bank is a powerful tool for monetary policy

– Interest rates– Reserve requirements– Open market operations– Federal funds rate

Fiscal Policies

• Fiscal policy refers to the government’s taxing and spending decisions

• The Treasury Department plays an important role

• Taxation– Tariffs, income tax, corporate tax, Social Security taxes, excise tax

– Progressive vs. regressive taxation

Federal Revenues

US Budget Deficits and Surpluses, 1962–2009

Clicker Question

Government decisions in the area of taxing and spending are thought of as:

A. Keynesian economics.B. regulatory policy.C. fiscal policy.D. monetary policy.

The Uncontrollables

Budget Outlays

The Economy and the Environment

• There is a tension between promoting economic growth and protecting the environment

• Climate change represents a controversial illustration

American Worries About Environmental Problems

Clicker Question

According to Table 15.2, which of the following environmental problems do Americans worry about least? Why?

A.Plant and animal extinctionB.Air pollutionC.Toxic wasteD.Global warming

The Politics of Economic Policymaking• The two major political parties differ with respect to economic policy– Republicans tend to favor policies that promote economic growth

– Democrats tend to favor policies that promote the environment and social equality

• Since 2008, these arguments have become more salient and they will surely be the key dividing lines in 2012