Monetary and Fiscal Policy

1. GOVERNMENT
MANIPULATION
OF THE
ECONOMY

2. When the economy is
doing badly, should we do
something to try to fix it,
or should we leave it
alone?
CENTRAL QUESTION:

3. Classical economics refers to work done
by a group of economists in the eighteenth
and nineteenth centuries. It stressed
economic freedom and promoted ideas
such as laissez-faire and free competition.
Classical economists like Adam Smith
believed that the economy is self-regulating:
supply and demand naturally move back to
equilibrium when there are imbalances.
CLASSICAL ECONOMICTHEORY:

4. CLASSICAL ECONOMICTHEORY:

5. In the long-run, the economy
works itself out. Recessions
eventually turn back into growth,
and disequilibrium becomes
equilibrium again.
But,“in the long run,
we are all dead.”

6. 1883-1946
JOHN MAYNARD KEYNES:
Famous British
economist
who changed the
way we look at
macroeconomics by
promoting the idea
that governments
should try to stimulate
the economy.
When the Great
Depression happened, I
decided that there must be
some way we can prevent this
disaster from
reoccurring!

7. IDEAS…
JOHN MAYNARD KEYNES:
• Optimal economic performance can be achieved
(and economic recessions prevented) by increasing
aggregate demand through economic intervention
policies by the government.
!
• The market is imperfect, and not self-sustaining.
!
• Consumer income stimulates demand, which causes
economic growth.
!
• Thus, when economic growth is lacking, the
government should find ways to stimulate consumer
demand.

8. Monetary policy is one of the ways that
governments attempt to control the economy.
!
!
!
The monetary authority of a country (usually a
central bank) controls the supply of money,
often targeting a certain interest rate for the
purpose of promoting economic growth and
stability.
MONETARY POLICY:

9. Types of monetary policies:
MONETARY POLICY:
Expansionary
Monetary
Policy
Contractionary
Monetary
Policy
Helps speed up
the economy,
or increase
economic growth
Helps slow down
the economy,
or slow economic
growth

10. MONETARY POLICY:
Expansionary monetary policy is used to increase
economic growth.The target growth rate is somewhere
around 2%, because we want growth without causing
too much inflation.
!
BAD:
-5% growth
BAD:
10% growth
GOOD:
2% growth
Remember: inflation is a side-effect
of economic growth.

11. MONETARY POLICY:
How do we increase economic growth?
One way to increase growth is to lower the interest
rates that people pay on loans and mortgages. If
people save money by paying low rates for the money
they must borrow, they will have more money to spend:
this money will circulate back into the economy, helping
businesses grow and prosper.
Consumer spending
stimulates economic growth

12. MONETARY POLICY:
Contractionary monetary policy is used to slow
economic growth.The goal is not to cause recession, but
to temporarily slow growth to lower inflation.
!
Why lower inflation?
High inflation causes the purchasing power of consumer
money to decrease, which means people will be forced
to buy less. Ultimately, high inflation can lower
nationwide demand, and cause economic recession.
BAD:
-2% inflation
BAD:
6% inflation
GOOD:
2% inflation

13. MONETARY POLICY:
How do we lower inflation?
Raising interest rates on loans and
mortgages helps slow economic
growth, because people will be
forced to pay more when they
borrow money from banks. People
have less money to spend in the
economy, the lack of money flowing
into the economy causes recession,
and recession lowers inflation.

14. FISCAL POLICY:
Fiscal policy is another way that governments
attempt to control the economy.
!
!
!
!
!
Governments adjust tax rates and government
spending for the purpose of promoting
economic growth and stability.

15. FISCAL POLICY:
How does lowering taxes
create growth?
If people are paying less in
taxes, they have more money
to spend or invest. Increased
consumer spending or
investment could improve
economic growth.
Governments don’t want to
see too great of a spending
increase though, as this could
increase inflation.

16. FISCAL POLICY:
How does gov. spending create growth?
The government might decide to increase its
own spending – say, by building more highways.
The idea is that the additional government
spending creates jobs and lowers the
unemployment rate.

17. FISCAL POLICY:
Expansionary fiscal policy is used to
increase economic growth.This is when
governments cut taxes or increase
spending.
Contractionary fiscal policy is used to
decrease economic growth.This is when
governments increase taxes or decrease
spending.

18. The terms “expansionary” and “contractionary” are used the
same way in relation to fiscal policy as to monetary policy.
FISCAL POLICY:
Expansionary
Fiscal
Policy
Contractionary
Fiscal
Policy
Helps speed up
the economy,
or increase
economic growth
Helps slow down
the economy,
or slow economic
growth

19. Remember that, in theory, increasing consumer spending
(or demand) stimulates the economy.
FISCAL POLICY:
Expansionary
Policy
Contractionary
Policy
Increases
aggregate
demand (or
nationwide
consumption)
Decreases
aggregate
demand (or
nationwide
consumption)

20. COMPARE: TOOLS USEDTO
INFLUENCE AGGREGATE DEMAND
Government Role in the
Economy
Monetary Policy Fiscal Policy
Bonds
Interest Rates
Reserves Taxing Spending