Lesson Objectives:- Recessions, unemployment, and inflation
- Fiscal policy
- Public debt
- Monetary policy
Ups and downs in the economy are to be expected and when a recession hits, the government tries to be proactive.
A recession is an economic downturn, usually characterized by a fall in the GDP and rising unemployment.
Unemployment is the inability of those who are in the labor force to find a job.
Another characteristic of recession is inflation, or a sustained rise in the general price level of goods and services.
Studies show that unemployment not only traumatically affects a person, but the whole economy. That is why it is a goal of the government to combat high unemployment rates and put programs in place like unemployment insurance, which is provided to hardworking Americans who find themselves out of a job by no fault of their own.
Doing an accurate count to measure unemployment is difficult and it changes every year, but it has steadily fallen since 2009 by the Bureau of Labor Statistics. One complication of measuring unemployment is determining who is actually considered unemployed – people who have dropped out of the workforce and have given up on looking for a job are not counted as unemployed. This percentage of the population that makes up the "hidden unemployed" dramatically increased during the Obama years, with the workforce participation rate dropping to a 38-year low of 62 percent in 2015.
There are two ways of looking at inflation. One is that it reflects the rising costs of products and services. The other is that it is actually a decline in the purchasing power of the dollar. Inflation is measured using the CPI, or Consumer Price Index, which is calculated by placing items purchased by a typical consumer in a market basket of consumer goods and services. The Bureau of Labor Statistics then rechecks the cost of that market basket over a period of time.
Today's dollar has roughly the purchasing power of a nickel in 1916, when you could buy a loaf of bread for a quarter.
Economists look at the ups and downs of economy as the business cycle. Recessions are often mild and have happened regularly over the past 30 years, but in the 1930s, there was an unusually severe recession called the Great Depression. Since the Great Depression, the government has used several policy options to try to control the ups and downs of the economy.
One approach the government uses to manage the economy is Fiscal Policy. That is the federal government's use of taxation and spending policies to affect overall business activity.
John Maynard Keynes was a 20th century economist who proposed active federal government policymaking to stabilize economy-wide fluctuations, including the use of discretionary fiscal policy. He believed that when the economy went through a downturn, the government should stimulate spending by increasing its own spending or cutting taxes to encourage taxpayers to spend more on goods and services.
The idea was the following: when people are unemployed, they have nothing to spend. When people have nothing to spend, businesses fail, creating a vicious cycle resulting in more unemployment.
Keynes' principle was that government spending would put money into the cycle where it is needed. But, there was a particular way it had to be done -- the government had to spend more than it received, creating a budget deficit.
Keynes policy was meant to be used in major disasters like the Great Depression, but under President Kennedy, policymakers began to use the method to "fine-tune" the economy through what is known as discretionary fiscal policy.
The problem with any solution is the timing. First, it takes time for the problem to be identified. It can then take years to get Congress to act. The implementation of the solution they come up with can take years before the changes are visible. Years have gone by and the recession could very well have righted itself before the effects of the solution are seen.
It is easier and more efficient to grant tax cuts to boost the economy than it is for government spending to spark it.
Of course, not everyone is on board with the Keynesian school of thought. Opponents say that fiscal policy has negative side effects that cause more damage than any benefits are worth. Other opponents simply say it is best that the government do nothing and let recessions work themselves out.
The system the government uses to borrow money is through U.S. Treasury bills, simply called Treasuries.
Treasuries are actually U.S. Treasury securities— bills, notes, and bonds; debt issued by the federal government.
The government sells these Treasuries to corporations, private individuals, pension plans, foreign governments, and foreign individuals. That is what gives us our public debt, or national debt.
The *net* public debt is really what is important because our *gross* public debt includes what our own government agencies borrow from each other. The net public debt is everything NOT including interagency borrowing.
Sticking with fiscal policy, the government consistently spent more than it received each year from 1960 to 1998. The ongoing budget deficits were blamed on negative effects of fiscal policy while other observers said the deficits were due to an abuse of the policy. The fact is, there is another side to the policy that Keynes proposed.
According to Keynes, during boom times, the government is supposed to run a budget surplus, receiving more than it spends. Or at the very least, it should keep the growth of debt below the growth of GDP.
There are problems we could face if deficit spending continues. Even though it is possible to continue selling treasuries and spending more than we have, many economists fear that prolonged deficit spending could cause the world to lose faith in our government, which could lead to higher interest rates and, in a vicious cycle, lead to larger deficits.
Fiscal policy is not the only tool the government has at its disposal to try to control the economy. Monetary Policy is another and involves the use of changes in the amount of money in circulation to alter credit markets, employment, and the rate of inflation.
The Federal Reserve System (the Fed) is the system created by Congress in 1913 to serve as the nation's central banking organization, and one of its most important tasks is to monitor the amount of money in circulation.
Appointed by the president and approved by the Senate, the board of governors consists of 7 full-time members. They preside over 12 district banks and the most important body called the Federal Open Market Committee. The Federal Open Market Committee decides how monetary policy should be carried out.
One important note is that the Fed is completely independent. Although the members of the Federal Reserve Board are appointed by the president and approved by the Senate, they do not have power over the Fed. It is inaccurate when someone refers to certain monetary policy as being of the president or Congress.
The Fed's goal is to stabilize the economy and it does that by controlling the amount of money in circulation. It has tools that it can use. Credit and the interest rate can be used to encourage economic growth as well as inflation.
There are two main approaches to monetary policy. A loose monetary policy means increasing the supply of credit and dropping the cost of borrowing. That encourages economic growth when a business can afford to borrow more money for more projects. The Fed uses tight monetary policy to decrease the supply of credit and raise the cost of borrowing. The goal of tight monetary policy is to control inflation.
The same time lag exists for monetary policy as it does for fiscal policy. Nothing the government ever does has an immediate effect, but the effects of monetary policy are usually seen sooner.
Also, the Federal Open Market Committee can put monetary policy together more quickly than the government can change its spending and borrowing habits.
The fact is that monetary policy can be effective during most recessions. If the Fed uses loose monetary policy, it can greatly increase economic activity which is exactly what a recession needs… That is, if people are actually borrowing and banks are actually lending.
During the Great Recession, the Fed dropped the interest to zero, yet businesses still were not borrowing. People were reluctant to use the credit. Economists compared it to "pushing a string" -- even though you can control the supply of credit and the interest rate, you cannot grab people by the hand and force them to take the money.
That is why the Obama administration went with fiscal policy to try to turn the economy around. President Obama obtained legislation from Congress that pushed the public debt to levels not seen since World War II, especially through his $800 billion economic stimulus package. Little effect was seen with unemployment rates remaining high. Keynesian economists argued that the stimulus was less than half of what was needed to accomplish such a goal.