Section 12.6 β€” Economic Policies 

  • πŸ›οΈ Two Main Economic Policies

    • There are two major policies that shape the U.S. economy:

      • Fiscal Policy β€” Controlled by Congress & the President

      • Monetary Policy β€” Controlled by the Federal Reserve Board (FRB)

πŸ’° Fiscal Policy:

  • Refers to government spending and taxation decisions.

  • Designed to influence overall demand in the economy.

  • Takes time to implement (political process).

  1. Keynesian (Demand-Side) Theory

    • Founded by John Maynard Keynes.

    • Belief: Government must actively manage demand to maintain stability.

    • Too little demand β†’ unemployment

    • Too much demand β†’ inflation

  2. To increase economic activity (stimulate growth):

    • Decrease taxes β†’ more disposable income β†’ more spending β†’ higher demand

    • Increase government spending β†’ more projects β†’ more jobs

  3. To decrease economic activity (fight inflation):

    • Increase taxes β†’ less disposable income β†’ less spending β†’ lower demand

    • Decrease government spending β†’ fewer projects β†’ higher unemployment

🏦 Monetary Policy β€” The Federal Reserve (The Fed):

  • Managed by the Federal Reserve Board (FRB) under the Federal Reserve Act of 1913.

  • The FRB is the nation’s central bank and directs the Federal Reserve System, which includes:

    • 12 regional Federal Reserve Banks

    • Hundreds of member banks

  1. Main Goals of the FRB:

    1. Promote maximum employment

    2. Maintain stable prices (control inflation)

🏭 Supply-Side Theory

  • Opposite of Keynesian approach.

  • Believes in minimal government involvement.

  • The economy grows best when businesses are strong.

  • Advocates for lower taxes and less regulation.

  • Healthy businesses β†’ more hiring β†’ higher production β†’ stronger economy.

  • Emphasizes free markets controlling prices naturally.

πŸ’΅ Monetarist Theory:

  • Founded by Milton Friedman.

  • Focuses on controlling the money supply to manage the economy.

  • Increasing the money supply β†’ stimulates economy (creates jobs).

  • Decreasing the money supply β†’ slows economy (reduces inflation).

  • But too much expansion = high inflation.

Policy

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Policy 〰️

πŸ“Š Money Supply Categories

Measure / What It Includes / Notes

  • M1 / Most liquid money β€” cash, coins, checking accounts (DDAs) / Closest to being spent

  • M2 / M1 + savings accounts, retail CDs, short-term deposits / Easily moved to M1

  • M3 / M2 + large time deposits (jumbo CDs, repos) / Harder to spend

βš™οΈ The Fed’s Tools

  • The Fed has:

    • Diagnostic tools = measure the economy (like a ruler).

    • Direct tools = adjust the money supply (like a wrench).

🧩 Open Market Operations (Most Common Tool)

  • The Fed buys or sells U.S. government securities (T-bills, notes, bonds) to influence the money supply:

Fed Action / Effect on Economy

  • Buys Securities / Money enters the economy β†’ Money supply ↑ β†’ Interest rates ↓ β†’ Borrowing & spending ↑ β†’ Economy expands

  • Sells Securities / Money leaves the economy β†’ Money supply ↓ β†’ Interest rates ↑ β†’ Borrowing & spending ↓ β†’ Economy contracts, inflation ↓

✺ Review questions ✺

  • Congress and the President

  • Too much demand

  • Cut taxes and increase spending

  • Encouraging business growth through lower taxes and less regulation

  • Maximum employment and stable prices

  • Money supply increases

  • Savings accounts

  • Milton Friedman

  • Sell government securities

  • Monetary policy