Economic Policymaking Everybody has to * Borrow money to go to college * Get a job * Borrow to buy a home * Pay off student loans * Save for retirement * Pay off student loans * What does Political Science have to do with that? * We believe in "free markets", but ... * If the government can help people make money and buy stuff, why not? Pocket guide to economic terminology * Unemployment (% of job seekers who don't find jobs) Terms (cont.) * Inflation (increase in prices) Terms (cont.) * Recession (reduced output & employment) * Business cycle: cycles of growth & recession * This is "macroeconomic" policy Macro Different From Micro * Previous: Microeconomic: industry specific * Macroeconomic tools: usually not focused to specific industries * Some gray area: some industry so big (auto) that micro policies affect the macro economy. What does it all mean for me, Paul Johnson? Federal Policy on the Macro Economy Divides into * Monetary policy * Interest rates * Lending * Borrowing * Fiscal Policy (not "physical") * Tax * Spend Monetary Policy * Primarily Controlled by the Federal Reserve Board * FRB created(1913): The MOST Powerful independent regulatory agency * Sells treasury bonds * Regulates banks Federal Reserve FRB also Sells Bonds * If FRB wants to "take money out of economy", it will sell bonds with good interest rates (encourages consumer saving, discourages consumption (purchases)) * If FRB wants to encourage spending, it lowers the interest rate so that consumers don't save so much. How is that Political? * Policy controls * how much money consumers have * how much banks loan to you * how much they charge for loans * If FRB policy is "tight", it means they discourage banks from lending money Big Questions about the FRB * Does the FRB generally favor * Banks, or * Consumers? * If too much lending, we end up in a banking crisis * Recall the mortgage crisis of 2009->2011 * Consequence: recession Claim: FRB Has Caused Recessions by Mistake * Nobel prize winner Milton Friedman did historical research which blamed most economic slowdowns from 1920s-1990s on mistakes by the FRB * FRB accidentally tightens too much * FRB response: we have better data now to make smaller, more precise adjustments Tax Policy * Federal Taxes on Income allowed by Constitutional amendment in (1916) * Key idea * We don't want to discourage earners, so a person should be able to keep (some) of each additional dollar she earns. Marginal Tax Rates * Marginal: how much of each additional dollar is paid in taxes? * Key idea: overall tax rate is not key issue. * Key issue is how to set marginal rates Political Question * We agree that the first $5000 earned by a poor person should be taxed at the same rate as a rich person, but * Should the last $5000 earned by poor person be taxed at the same tax rate as the last $5000 earned by a rich person? * Rate on $1,000,000 earner versus * Rate on $10,000 earner Progressive and Regressive * Progressive Tax: % tax rises with income * Income tax (graph next page) Payroll Tax Can be Regressive * Regressive Tax: % tax declines with income * Ex: Social Security payroll tax * Dollars earned by low earners are taxed at 6.2% * After "threshold", marginal rate reduced to 0 Tax Politics and the Fiscal Cliff * Congress & the President constantly tempted to fiddle with marginal tax rates * PJ claim: tax politics is an example of instability in multi-dimensional voting. * Reforms periodically * raise/raise rates * create/eliminate exceptions The Fiscal Cliff: Jan. 1, 2013 * Cong & President adopted temporary tax reductions in the past. * Reductions expire Jan. 1. * Forecast: * Reversion of tax rates will shock economy * We wait to see if Pres, Dems and Repubs can pass new law to prevent Spending * Congressional Process: * authorization (creates programs) * appropriation (pays for programs) * Deficit: spending exceeds revenue. Federal Budget * Defense: 20% * SS & Medical: 40% * Difficult to see where to cut spending without confronting those 2 big blocks of spending Deficit Long Term View Deficit: Short Term view Budget Process * Until 1974, no formal process existed to match revenue and spending. * 1974 law created new Budget Process * Tax/Spending "targets" created in spring * Appropriation laws were supposed to fit together into overall budget. * Problem: No external "Enforcement" of Process Congress Doesn't Police Itself * Targets not "binding" on Congressional "appropriations process" * Hence: targets often ignored * Extraordinary Congressional maneuvering required to enforce limits on spending: * 1981. Reagan & Republicans * 1990s- Clinton Dems eliminated deficit Major Challenge * Uncontrollable Expenditure * Uncontrollable: appropriations can't touch it. * Entitlements growing section of budget * Authorizing laws create Social Security and Medicare obligations, and those are OUTSIDE of the budget appropriations process Budget: Example of Rising Presidential Role in Policy * Congress often incapable of passing either * Budget targets or * Expenditures that match targets * Rising presidential role in negotiating high-level compromise among parties. * Rising importance of presidential "central clearance" Accumulating Debt Who Cares About Debt? * Some worry: * debt repayment expenses * harmful influence of debt holders (China) * Some don't worry * deficit spending stimulates economy We've been in crisis before * Recall temporary Government "Shutdowns" under Bush 1 and Clinton: * Cong & Pres could not agree on law to allow federal borrowing * Obama & Congress deadlocked, extension was tied to promises about overall budget reform and the 'super committee' (which accomplished nothing).