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Unit 7 Macroeconomics: Taxes, Fiscal, and Monetary Policies Chapters 16.4. Economics Mr. Biggs. Monetary Policy and Macroeconomic Stabilization. Monetarism - The belief that money supply is the most important factor in macroeconomic performance. How Monetary Policy Works

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Presentation Transcript
slide1
Unit 7 Macroeconomics:

Taxes, Fiscal, and Monetary Policies

Chapters 16.4

Economics

Mr. Biggs

slide2
Monetary Policy and Macroeconomic Stabilization

Monetarism - The belief that money supply is the most important factor

in macroeconomic performance.

How Monetary Policy Works

Monetary policy alters the supply of money which then affects:

  • Interest rates
  • Level of investment and spending
slide3
The Money Supply and Interest Rates

When the money supply is low,

interest rates are high.

When the money supply is high,

interest rates are low.

Interest Rates and Spending

Easy money policy - Monetary policy

that increases the money supply by

decreasing the discount interest rate.

It is used to encourage business

investment.

Tight money policy - Monetary policy

that reduces the money supply by

increasing the discount interest rate.

It is used to discourage business

investment, slow down the

economy, and minimize inflation.

slide4
The Problem of Timing

Monetary policy must be timed carefully

because if they are enacted at the wrong

time, they could actually intensify the

business cycle, rather than smooth it out.

Good Timing

Good timing will lower the peaks

and make the troughs less deep.

This will minimize inflation in

the peaks and the effects of

recessions in the troughs.

Bad Timing

Poor data or policy lags can

cause economists to not time

monetary policy properly.

This can actually make the business cycle worse.

slide5
Policy Lags

There are a couple of problems in the timing

of macroeconomic policy:

    • Inside lags
    • Outside lags

Inside Lags

Inside lags - Delay in implementing

monetary policy.

Inside lags occur for two reasons:

    • It takes time to identify and recognize a problem
    • Once a problem has been recognized, it can take time to politically enact appropriate policy
  • Fiscal policy requires actions by Congress and the President and can take quite a while to enact.
  • Monetary policy’s inside lag is streamlined because the FOMC meets 8 times a year and can make open market policy or discount rate changes almost immediately.
slide6
Outside lags
  • Once a new policy is determined, it
  • takes time to become effective.
  • Outside lag - The time it takes for
  • monetary policy to have an effect.
  • For fiscal policy, the outside lag lasts as long
  • as is required for the new government
  • spending or tax policies to take effect.
  • This can be a short amount of time.
  • For example, tax rebates.
  • Outside lags can be much longer for monetary policy since they primarily affect business investment plans.
  • For example, firms may require months or even years to make large physical capital investment plans.
  • Because of the political difficulties of implementing fiscal policy, we rely to a greater extent on the Fed to use monetary policy to soften the business cycle.
slide7
Predicting the Business Cycle
  • The Federal Reserve must react to current trends
  • as well as anticipate changes in the economy.

Monetary Policy and Inflation

Given the timing problems of monetary

policy, in some cases it may be wiser to

allow the business cycle to correct itself

rather than run the risk of an ill-timed

policy change (laissez-faire).

On the other hand, if we expect a

recession to last several years, then

a more active policy is recommended.

How Quickly Does the Economy Self-Correct

Economists disagree, but they estimate that the US

economy can self-correct in 2 to 6 years.

slide8
Approaches to Monetary Policy
  • Laissez-faire economists who believe that the economy will self-adjust quickly will recommend against enacting new policies.
  • Economists who believe that economies emerge slowly from recessions will usually recommend enacting fiscal and monetary policies to move the process along.
  • The chart below shows how the federal government and the Federal Reserve can influence the nation’s economy.
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