Economic Policy ALM Voiceover Script

Economic Policy: The Connection Between Government and Economics

In this Animated Learning Module, you will learn about economic policy and the connection between government and economics.

Policy: The Effort Made to Achieve Some Outcome

A policy is the effort to accomplish a particular goal. The goals of economic policy are growth, stability, low unemployment, and low interest rates.

Growth occurs when the gross domestic product or GDP increases. The GDP is a measure of the economy tied to what is produced. An increase in production is a positive measure of the economy.

Stability means there are minimal variations in the measurement of the economy. Variations make it difficult to plan future activities.

Low unemployment means that more people are working and generating demand for goods and services as well as paying taxes. When unemployment rises, fewer people are paying taxes and generating less demand.

Low interest rates mean the cost of borrowing money is cheaper, making it possible to consume more. When consumption goes up, production goes up.

Economic conditions determine which actions are taken by the government. For example, when the economy is growing, there is fear that it will lead to inflation. Inflation is the condition of too many dollars chasing too few goods. This results in the devaluation of the dollar. Ultimately, your pay goes down because you need more dollars to buy what you want.

The economy sometimes declines in GDP, causing it to head towards a recession. If this decline occurs over two economic quarters then there is a recession. If this declining GDP continues and causes a severe economic decline we would call it a depression.

Government Influence: What Can It Do?

Now, let’s take a look at some of the things government can do to influence the economy.

Taxes are a means of generating revenue for the government; however, it also takes money out of the economy. This has the ability to slow the economy down.

One form of tax is the progressive income tax. It is called progressive because the burden of the tax goes up as you earn more money.

1 Sales taxes are regressive because they put a burden on the poor. The poor have less money after buying the same goods as the wealthy because the tax rate is uniform.

Property taxes are typically based on the value of property and represent a considerable expense to homeowners. For example, taxes paid to a school district are a drain on a particular community. Often, homebuyers will look for the communities with lower property taxes before buying.

Excise taxes are often applied to certain products such as gasoline. Every gallon of gasoline purchased in America is taxed, which pulls money from the economy.

Although there are many different taxes, we will end with the Social Security tax, which represents 6% of your income. Your employer also pays 6% of your income in Social Security taxes.

Besides taking money out of the economy, government can spend and put money into the economy.

This spending can come in the form of social welfare programs. This redistribution of wealth can impact portions of the economy.

Spending can also come in the form of public goods, such as infrastructure projects. The influence only benefits the segment of the economy using the money, such as a construction project to build a new bridge.

Recently, there has been a wave of bailouts for banks and car companies. This is sometimes called corporate welfare.

The Economy is Cyclical

The economy experiences something known as the business cycle. In other words, the economy goes through changes based on normal business activity. For example, swimsuits are in greater demand in the summer and may cost more. Wool hats are in less demand in the summer and may cost less. Producers ramp up production to meet demand and may hire more workers. When demand is low, employers may let employees go.

The most sought after condition is growth. Simply put, demand for goods and services are causing producers to produce more and hire more workers.

One cycle of the economy we want to avoid is inflation. Remember, inflation is the result of too many dollars chasing too few goods. In other words, the general level of prices goes up so that it appears as if your income goes down.

Recession is another condition that we want to avoid. Recession officially occurs when there are two consecutive economic quarters of negative GDP. In other words, the economy is shrinking.

2 Depression may be the worst of all conditions because it represents a significant downturn in the economy, such that there is no growth over a long period of time.

Government seeks to influence the economy at each of these points in the cycle; however, there is a special policy in which the government can be limited, thus allowing the free market to improve on its own. This is sometimes referred to as supply-side economics.

As you learned earlier, growth is best evidenced by an increasing GDP. However, growth can also be realized by a decreasing unemployment rate. As more individuals enter the workforce, they spend their money, creating greater demand. Demand drives production. Production drives further employment and so on.

The trigger for such economic activity comes from lowering taxes. When taxes are lowered, it frees up the money that people have earned, allowing them to spend more and drive production. In the long run, this means greater revenue for the government because more people are working and paying taxes.

Fiscal Policy: Tax and Spend

Fiscal policy is a tool of government, which involves taxing and spending to influence the economy. Typically, when there are signs of a recession, some believe it is best for the government to spend enormous sums of money to get the economy going. Others believe that this approach has no real impact on the economy and only increases deficits and debt.

Fiscal Policy

Fiscal policy says that the government should spend less and tax more when the economy is growing too fast in order to avoid inflation. This tightens the economy.

And, when the economy is moving toward recession, fiscal policy says that government should spend more and tax less. This causes the economy to loosen.

Remember, in the first case the idea is to take money out of the economy. In the second case the idea is to put money into the economy.

A significant problem with this approach is that we don’t know with great certainty where the economy is going, we only know where the economy has been. When fiscal policy is applied at the wrong time, it could make things worse.

Monetary Policy

Another approach to achieving economic growth and stability is called monetary policy. Monetary policy deals with the supply of money in the economy. Basically, monetary policy says that the supply of money should be limited or reduced to slow an economy down.

3 When the economy is not doing well or experiencing a recession, money should be put in the economy.

The Federal Reserve is the institution responsible for monetary policy along with the Treasury. Treasury bills can be bought and sold by the government to move money in and out of the economy. Interest rates on loans between banks and the Federal Reserve can also influence the flow of money in the economy.

Monetary policy is preferred by some over fiscal policy because we know more about the present supply of money than we do about where the economy is going.

Regulation Represents Cost

Regulation is a typical approach by the government to influence aspects of the economy. For example, banks may be required to make certain types of loans that they might not otherwise make in a true free market economy. Whether it is investment firms, automobile manufacturers, insurance companies, or energy companies, regulation costs money. The cost experienced by these firms is typically passed on to the consumer in terms of higher prices. These higher prices have a similar effect as inflation.

Borrowing Leads to More Expense

Some believe that the government can borrow money to meet its obligations and continue to function well in the economy and avoid raising taxes or printing more money. Borrowing, however, leads to more expense because borrowed money must be paid back with interest adding more to the debt. As of this moment, the national debt is approximately 13 trillion dollars.

Printing Decreases Value

Finally, government sometimes prints additional money to influence the economy. The theory is that if you print more money and put it in circulation, people will have greater access and spend it. However, what this actually does is lower the value of money requiring you to spend more. Essentially, it creates inflation because there is too much money chasing too few goods.

Critical Thinking Questions

1. What does fiscal policy require when the economy is growing?

2. What does fiscal policy require when the economy is slowing?

3. What are the consequences of monetary policy?

4. What are the consequences of inflation?

5. What are the consequences of taxation and regulation?