,CHAPTER 13,Stabilization Policy,1,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Questions,What principles should guide stabilization policy? What aspects of stabilization policy do economists argue about today? Is monetary policy or fiscal policy more effective as a stabilization policy? How does uncertainty affect the way stabilization policy should be made?,2,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Questions,How long are lags associated with stabilization policy? Is it better for stabilization policy to be conducted according to fixed rules or to be conducted by authorities with substantial discretion?,3,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Government Policy,There are two kinds of government policy fiscal policy shifts the IS curve monetary policy shifts the LM curve The government uses policy to stabilize the macroeconomy by minimizing the impact of shocks,4,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy Institutions,Monetary policy in the U.S. is made by the Federal Reserve which is the central bank the principal policy-making body of the Federal Reserve system is the Federal Open Market Committee (FOMC) the FOMC lowers and raises interest rates and increases and decreases the money supply,5,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy Institutions,The Federal Reserve has a central office and 12 regional offices the central office is the Board of Governors in Washington, DC the 12 regional offices are the 12 Federal reserve banks scattered around the U.S. the members of the Board of Governors and the Presidents of the regional Federal Reserve Banks make up the FOMC,6,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.1 - Structure of the FederalReserve System,7,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.2 - Composition of the Federal Open Market Committee,8,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy Institutions,The FOMC meets approximately once a month to set interest rates emergency meetings can also be scheduled on short notice When the FOMC decides on a policy change, it is implemented immediately it takes only minutes for interest rates to shift in response to FOMC actions,9,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy Institutions,The FOMC changes interest rates by carrying out open-market operations in an expansionary open-market operation, the Federal Reserve buys government bonds, increasing bank reserves, and lowering interest rates in a contractionary open-market operation, the Federal Reserve sells government bonds, decreasing bank reserves, and raising interest rates,10,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy Institutions,The Federal Reserve can also alter interest rates in two other ways the Board of Governors can alter legally required bank reserves the Board of Governors can lend money directly to financial institutions These tools are used very rarely,11,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Fiscal Policy Institutions,Fiscal policy in the U.S. is managed by Congress the Congress creates the tax laws that determine the amount of taxes imposed by the federal government the Congresss spending bills determine the level of government purchases Tax and spending levels are set through a process called the budget cycle,12,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.4 - The Budget Process,13,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Government Expenditures,Mandatory expenditures include spending for Social Security, Medicare, Medicaid, unemployment insurance, and food stamps Discretionary expenditures must be appropriated each year by Congress these include defense spending, NASA, highway spending, education spending, and so forth,14,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.5 - Major Federal Government Expenditures by Category, 1960-2000,15,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.6 - Federal Government Discretionary Spending, Excluding Defense (2000),16,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Fiscal Policy Institutions,Because of the way the budget process is set up, making fiscal policy in the U.S. is complicated and time-consuming the time between when a policy proposal is made and when it becomes effective (the inside lag) can take years the inside lag associated with monetary policy changes can be measured in days or weeks,17,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The History of Economic Policy,The Employment Act of 1946 established Congresss Joint Economic Committee and the Pres