Lecture08 - The Emergence of Countercyclical Strategies of...

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Unformatted text preview: The Emergence of Countercyclical Strategies of Economic Management Lecture 8: Halting Experiments with Fiscal and Monetary Policies in the Associational Era Introduction Regulation associational style Develop strategies to moderate wild swings in the business cycle ("Boom and Bust") Politically intolerable levels of overproduction, underconsumption, unemployment, wage cuts, business failure Introduction Regulation associational style Government coordination of industrial activity through trade associations The promotion of efficiency The development of open pricing systems The negotiation of codes of fair market conduct Introduction Regulation associational style Development of rational strategies for Reducing costs of production without touching labor Restricting the range of price fluctuations Restraining cutthroat forms of competition Introduction Additional strategies for regulating the macroeconomy in the Associational Era Countercyclical fiscal policy Strategic use of government's budgetary authority (its taxing/spending power) to stimulate market activity when economy is weak to dampen market activity when economy is overheating. Introduction Additional strategies for regulating the macroeconomy in the Associational Era Countercyclical monetary policy Strategic use of govt's influence over nation's money supply (and thereby over bank interest rates) to stimulate new borrowing (and hence new private spending) when economy is weak; to dampen new borrowing (and hence new private spending) when economy is overheating Introduction In the spirit of Associationalism Strategies to moderate wild swings in the business cycle Without building up the state's directive and coercive powers Indirect influence on business: Manipulating incentives in the decision making environment of business The Emergence of Countercyclical Fiscal Policy The Depression of 1921 The President's Conference on Unemployment The Problem: Unemployment resulting from end of Problem WWI Demobilization (increase in supply of labor) Government spending for war stops (decrease in demand for labor) Price Level 25 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 35 45 55 65 75 85 95 Wholesale Price Index of Industrial Commodities, 1914-1945 (1967=100) Percent Unemployed 10 15 20 25 30 35 40 0 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 % Civilian Labor Force % Nonfarm Employees 5 U.S. Unemployment Rates, 1919-1945 The Emergence of Countercyclical Fiscal Policy Conference Report makes several recommendations The Emergence of Countercyclical Fiscal Policy Conference Report makes several recommendations Create employment services exchange National clearinghouse for job information National Employment Services Exchange: Pooling and Sharing Information on Local Job Markets Cinncinnati (hiring) Los Angeles ESE Rising Unemployment San Francisco (hiring) New Orleans (hiring) The Emergence of Countercyclical Fiscal Policy Reduce hours/days of work across the board Pool risk Everyone shares in the pain of "hard times" Example: A firm regularly employs 4 full-time workers (40 hrs./wk) Now, only has need for 3 full-time workers Don't fire one employee Reduce everyone's work by 10 hrs (10x4=one 40 hr. worker) The Emergence of Countercyclical Fiscal Policy Reduce wartime taxes (personal/corporate) Stimulate demand/new investment The Emergence of Countercyclical Fiscal Policy Reduce wartime taxes (personal/corporate) Stimulate demand/new investment Raise tariffs Protect workers from competition using cheap labor The Emergence of Countercyclical Fiscal Policy Report's main recommendation: The coordinated use of govt spending authority to manage the business cycle Key instrument: Public works spending The rational release of public funds into economy The problem of timing Knowing when to release public money The Emergence of Countercyclical Fiscal Policy Avoid government spending that follows the business cycle Boom phase: Public/private competition for scarce labor and materials fuels inflation in economy Bust phase: Simultaneous slowing of private AND public spending intensifies recessionary trends in economy The Emergence of Countercyclical Fiscal Policy Govt has to release its public works countercyclically Counter to the business cycle Compensatory spending The Emergence of Countercyclical Fiscal Policy Expand public works spending during downturns Both a direct and indirect stimulus to economy The Emergence of Countercyclical Fiscal Policy Direct stimulus: Govt projects employ workers would otherwise be out of work or underemployed. Competition for labor buoys private sector wages too Indirect stimulus: Govt demand for materials stimulates activity in other sectors of economy Spending by workers in govt projects stimulates activity in other sectors of economy Business Cycle: Boom and Slump Phases PEAK Inflationary Pressures Mount Unemployment Pressures Mount TROUGH Business Cycle: Boom and Slump Phases PEAK Inflationary Pressures Mount Unemployment Pressures Mount Approaching Peak of Boom Phase Demand for money Demand for raw materials Demand for labor Supply of money Supply of raw materials Supply of labor Market demand Production at near full capacity Costs of production Prices INFLATION TROUGH Business Cycle: Boom and Slump Phases PEAK Inflationary Pressures Mount Unemployment Pressures Mount Approaching Peak of Boom Phase Demand for credit Demand for raw materials Demand for labor Supply of credit Supply of raw materials Supply of labor Market demand Production at near full capacity Costs of production Prices INFLATION Approaching Trough of Bust Phase Demand for credit Demand for raw materials Demand for labor Supply of credit Supply of raw materials Supply of labor Market demand Prices Production levels Demand for labor Wages Unemployment TROUGH Government Spending that Follows the Business Cycle Intensifies Cyclical Pressures Inflationary Pressures Unemployment Pressures Government Spending that Follows the Business Cycle Intensifies Cyclical Pressures Government Spending Inflationary Pressures Unemployment Pressures Government Spending that Follows the Business Cycle Intensifies Cyclical Pressures Government Spending Inflationary Pressures Unemployment Pressures Government Stops Spending Countercyclical (or Compensatory) Government Spending Inflationary Pressures Government Reduces Spending Unemployment Pressures Government Increases Spending The Emergence of Countercyclical Fiscal Policy Proposal: Govt policy to hold budget surpluses in reserve to fund public works projects during economic contractions Depressions occur roughly once every 10 years 10% set-aside by Federal, state, local levels into public works reserve fund Release reserve when economy in downturn The Emergence of Countercyclical Fiscal Policy Not a call for deficit spending (govt is neither borrowing money nor cutting taxes) The Emergence of Countercyclical Fiscal Policy Not a call for deficit spending (govt is neither borrowing money nor cutting taxes) Not a call for a bigger federal government Fed govt not assigned primary responsibility A state and local obligation Of proposed $800 million reserve fund, feds put up 15% The Emergence of Countercyclical Fiscal Policy Consistent with associational ethos Federal govt helps coordinate cooperative local govt action Collect information on state of economy When statistical indicators indicate downturn in economy, fed govt signals time to release surplus The Emergence of Countercyclical Fiscal Policy Countercyclical spending doesn't make great inroads in 1920s Stiff blocks of opposition from Academic economists Efforts to manage the business cycle misguided Retain inefficient firms; hamper long-term performance of economy Congress/Treasury Dept Use any budget surpluses to pay off war debt and reduce taxes The Emergence of Countercyclical Fiscal Policy Others who argue that size of govt too small for countercyclical spending to have much impact Public sector spending accounts for 3.2% of GNP in 1929 Increase spending levels of find some other strategy Countercyclical Monetary Policy A second instrument for managing the macroeconomy in the 1920s Management of the nation's money supply Countercyclical or compensatory monetary policy Countercyclical Monetary Policy The Federal Reserve Board Coordinate the lending behavior of banks By effectively utilizing the tools at its disposal, the Fed could play an important role in regulating the business cycle Countercyclical Monetary Policy Federal Reserve has three tools with which to influence bank lending behavior Countercyclical Monetary Policy Federal Reserve has three tools with which to influence bank lending behavior Open Market Operations Buying/Selling of federal govt securities T-bills; T-notes; T-bonds Countercyclical Monetary Policy Federal Reserve has three tools with which to influence bank lending behavior Open Market Operations Buying/Selling of federal govt securities T-bills; T-notes; T-bonds The discount rate Interest rate the Fed charges other banks to borrow money from it Countercyclical Monetary Policy Federal Reserve has three tools with which to influence bank lending behavior Open Market Operations Buying/Selling of federal govt securities T-bills; T-notes; T-bonds The discount rate Interest rate the Fed charges other banks to borrow money from it Reserve requirement Amount of liquid assets banks are required to hold in reserve Countercyclical Monetary Policy Manipulating any one of these instruments effects interest rates (that is, the price banks charge for borrowing money) When all three used in coordinated fashion Fed can play important role in managing economic fluctuations Impact a function of timing and volume of Fed activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Interest Rates Higher ("Tight" Money Supply) More Expensive to Borrow Lower Amount of Borrowing Depress Economic Activity OMO Sell High DR High RR Buy Low Low Interest Rates Lower ("Loose" Money Supply) Cheaper to Borrow Greater Amount of Borrowing Stimulate Economic Activity Countercyclical Monetary Policy Obstacle to development of countercyclical monetary policy Decentralized structure of Federal Reserve System Countercyclical Monetary Policy 12 Federal Reserve Banks Each with autonomy to set monetary policy in its district (expansion/ contraction) Could (often did) work at cross-purposes Canceling each other out in the aggregate If decisions unintentionally reinforce each other Unintended consequences Decentralization and the Fed Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed No Effect Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed No Effect Dallas Contractionary New York City Contractionary San Francisco Expansionary Chicago Expansionary Decentralization and the Fed New York City Expansionary Dallas Expansionary Chicago Expansionary San Francisco Expansionary Decentralization and the Fed New York City Expansionary Dallas Expansionary Chicago Expansionary San Francisco Expansionary Decentralization and the Fed New York City Contractionary Chicago Contractionary Dallas Contractionary San Francisco Contractionary Decentralization and the Fed New York City Contractionary Chicago Contractionary Dallas Contractionary San Francisco Contractionary Countercyclical Monetary Policy A learning effect Benjamin Strong Leadership Convince other Fed Reserve governors of importance of coordination Timing/volume of open market actions ...
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This note was uploaded on 04/02/2008 for the course POL SCI 147C taught by Professor James during the Winter '08 term at UCLA.

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