Economic Policy
Economic Policy
Abdul M.
PLCY 700: Foundations of Statesmanship and Public Policy
June 3, 2019
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Key debates in fiscal and monetary policy
The interaction between fiscal and monetary policies as measured by public debt and
monetary policy as measured by a reaction function of a central bank causes change in monetary
policy due to deviations from their target rate that generates fiscal impacts (Bertella, 2015, 3).
Monetary and fiscal policies promote maximum employment growth and low, stable inflation.
In collaboration, the two policies can help keep an economy stable with minimal inflation, low
unemployment, and price transparency.
There have been several theoretical contributions to the theory of economic policy. The
economists theoretical approach relies on equilibrium conditions to derive empirically tractable
estimating equations. However, empirical evidence suggests that fiscal policy is far from a
steady state (Engen & Skinner,1992, 2). While using government purchases, taxes, and
borrowing to affect the employment rate, the price level, and the level of the GDP, a fiscal policy
enacts tools such as automatic stabilizers (federal income tax) and discretionary fiscal policy
(changes in government purchases) to affect macroeconomics. Unintentionally, the fiscal policy
may affect the aggregate supply. Monetary policy influences the quantity of money in the
economic system. The Fed’s control over monetary policy stems from its exclusive ability to
alter the money supply and credit conditions more broadly (Labonte, 2019, 1). Economics is a
philosophy and not an exact science. It’s about philosophical assumptions about how the state
should operate in the economy, how the state should control or not control the economy. (Fisher,
2019). The policymakers have a constant objective, to manage the nation’s money by restoring
and maintaining a stable economy whether it be in recession, full employment, or have an
inflationary gap.
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Economists regularly advocate a variety of reforms including the issuance of government
index bonds and predicting consumer behavior (Fischer & Summers, 1989, 382). They have
individual opinions and debate their views with one another. Therefore, there is no one way to
implement both monetary and fiscal policies for government reform in the nation’s economy.
Although the economy itself is self-correcting, it takes time to do so. Economists continue to
debate the issues that surround monetary and fiscal policies such as; spending, taxes, the deficit,
economic programs, and government intervention in economic activity.
The importance of monetary policy and fiscal policy as economic tools can
increase over time due to a number of factors. These factors such as the control of money
circulation, the stability of the economy, and the Feds ability to avoid a crisis, can be influenced
by the balance between savings and investment in the nation’s economy. Through monetary
policy, the government can regulate the amount of money in circulation. The target interest rate
is set by the Federal Open Market Committee (FOMC). To regulate the economy and meet the
target rate, the Fed will buy or sell US government securities and bonds by using an open market
(Cochran et.al, 2016,70). In turn, this will affect the amount of money the banks will have in
reserve available to lend to consumers and businesses. The economy will either increase,
decrease, or maintain the growth of the money supply in the banking system.
Low inflation is the long-term goal of the Fed and monetary policy is the key factor of
inflation. In general, monetary policy refers to the measures the Fed adopts to expand and
contract credit as the economic situation may demand (Raoof, Hassan, 1999, 170). The Fed
lowered the rate that banks could charge one another to borrow money to encourage lending and
stimulate the economy. In 2015, the Fed began to raise rates. It raised rates once in 2016, three
times in 2017, and four times in 2018, by 0.25 percentage points each time (Labonte, 2019, 2).
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Fiscal policy is the government’s ability to raise taxes and spend the money it raises.
Spending money and not raising taxes adds to our nation’s deficit. Over time the nation’s debt
has accumulated substantially. Deficit spending stimulates demand in a time of recession and
unemployment (Cochran et al., 2016, 71). Fiscal deficits take place when the government spends
more than it earns. The amount of the nation’s debt from the excess of government spending
contributes to macroeconomic stabilization. Government borrowing makes it possible to practice
deficit spending without fueling inflation, for the short term (Cochran et. al., 2016, 74).
Government spending and debt management are ways in which the government attempts to
influence economic activity.
One of the key debates in fiscal and monetary policy is government intervention in
economic activity. The effect of government involvement in the economy, as measured by
central government expenditures as a percent of Gross Domestic Product (GDP), on the
distribution of income, will have a negative influence on the income inequality only at high
levels of economic development (Boyd, 1988, 228). There is an issue concerning how much
debt the American economy can support. It remains unresolved. In comparison, the annual
deficit affects the GDP between 2 and 3 percent, when the total debt effects the GDP by nearly
50 percent. (Cochran et. al, 2016, 87). This puts pressure on the nation’s economy. To assist the
economy, the government will cut tax rates while increasing its own spending; to cool down an
overheating economy, it will raise taxes and cut back on spending (Hayes, 2019, 16). If taxes are
lowered on businesses and individuals, the individuals will have the ability to spend more
money, the businesses will have the ability to invest more, which will stimulate the economy and
it will grow.
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The government relies heavily on monetary and fiscal policies when it comes to
macroeconomics. Liberals assert that macroeconomic policies aimed at achieving an equilibrium
among savings, consumption, and investment promote economic growth, stimulate job creation,
and consequently, ameliorate unemployment and income inequality (Boyd, 1998, 223). Enacting
a monetary policy when the economy is faltering will stimulate growth by lowering interest rates
and increasing the amount of money in circulation within the economy. On the other hand,
enacting a fiscal policy will raise taxes and cutbacks in spending will become effective. In all
this, the Fed still has the control and the power to implement changes in policy and remove
money from circulation.
In addition, government intervention in economic activity is done through monetary
policy. The government is able to regulate the amount of money in circulation in the nation’s
economy. The bailouts in the early part of 2000 rewarded banks for risky investment
expenditures. Money was so cheap businesses could do a lot of debt leveraging but there was no
value being brought back into the economy. It is difficult for the government to predict and
forecast demand. Bad things happen when the state over involves itself in the economy (Fisher,
2019)
In 2008, The Emergency Economic Stabilization Act expanded the role of the federal
government which allowed it to regulate and control the American financial system. People
were able to borrow money for mortgages without the actual means to repay the loans. The
increase in mortgage defaults rose and a significant economic crisis was created with the
prospect of widespread failure of multiple banks and institutions (Cochran et al., 2016, 85). It
brought about an economic recession and an increased unemployment rate.
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Bank failures used to have a domino effect on other banks. If one bank failed all banks
failed. Consumers would hear of a failing bank and withdraw their money whether their bank
was failing or not. This would affect the economy and cause a recession. As America’s bank,
the Federal Reserve (the Fed) was created to control inflation and to encourage full employment
in our nation’s economy. The Fed helps banks acquire their reserves to meet panic withdrawals
so that the shortage at one bank won’t disrupt the entire banking system. After the run on banks
in the 1930s, the Fed decided to set a limit for banks to keep on hand in reserves. The fed also
sets regulations in terms of creditworthiness.
The interest rate banks pay to borrow money is determined by the Federal Reserve Bank
and it also determines the amount of money in circulation. It buys debt in the form of
government securities, which is essentially lending money to banks. This, in turn, increases the
amount of money in circulation and shifts the aggregate demand curve due to the bump in the
interest rate for individual borrowers. Should the Fed buy securities, it does so with the
equivalent of newly issued currency (Federal Reserve notes), which expands the reserve base and
increases the ability of banks to make loans and expand money and credit (Labonte, 2019, 4).
The Fed is not authorized to purchase securities directly from the Department of the Treasury.
They must purchase them from primary dealers. The Federal Open Market Committee (FOMC)
combines the Federal Reserve Act written by Congress and the efficiency of the National
payment system in setting monetary policy by making it easier for payments such as checks to be
exchanged through different parts of the country.
If taxes on businesses and individuals are lowered and the interest rates are low, people
will be inclined to spend more. They are willing to reinvest their money in home mortgages,
auto loans, and businesses. Businesses will be able to invest more, and the economy will grow.
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In macroeconomic terms, the Fed must perform a delicate balancing act by adjusting interest
rates to keep inflation intact. Lower interest rates equal growth in the economy. A growing
economy is good, but inflation is a constant threat. On the other hand, history shows no real link
between tax rates and economic growth. The U.S. economy has grown at a steady rate of an
average of 3 percent per year despite ups and downs in the corporate income tax rate (Rebelo,
2018, 16).
Entitlement programs are a large amount of the deficit and are they are continuously
growing. This mandatory spending for Social Security, Medicare, and Medicaid consume over
half of the federal budget. The aggregate generosity of the system has continually trended
upward, albeit with some pauses and slowdowns, and that the rate of spending growth has in fact
been greater in some recent periods than it was in the late nineties (Moffitt, 2016, 2). According
to the Center on Budget and Policy Priorities, in 2016, $916 billion was paid for Social Security
and $1 trillion on Medicare, Medicaid, and marketplace subsidies. Social Security checks and
medical benefits cannot legally be stopped when a budgetary spending ceiling limit is reached
(Cochran et al., 2016, 89). Congress must modify the programs through the change of policy. It
is difficult to predict how many families and individuals will need the assistance of an
entitlement program. The economy itself has a major influence on that need and it encompasses
factors such as the unemployment rate, inflation, and pre-planning during an active fiscal policy.
Key Failings of the State
In Losing Ground Murray does not shy away from his views regarding the overly
generous welfare system in the United States. The fight against poverty triggered several
programs and experiments in the quest to find the solution to the major social issue at hand.
Many of us will agree that President Lyndon Johnson’s social welfare philosophy had high
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expectations of not only tackling poverty and racial injustice but also gradually building a Great
Society (Levitan & Taggart, 1976, 601). The concept of the Great Society sparked various
government programs to help bridge the gap between the different races in terms of social,
economic, and legal foundations of inequality and deprivation (Levitan & Taggart, 1976, 601).
These programs, mostly experimental, were the government's economic intervention for
addressing the poverty pandemic.
Poverty wasn’t an issue that miraculously appeared in the 1960s, it was present all along,
the difference is the aggressive demand for natural rights of fairness and equality especially in
the distribution of economic benefits (Phelps, 1974, 30). Murray believed that these programs
weren’t as successful as everyone hoped. He also believed that these programs were over-
ambitious, conceded and lacked a sense of direction (Murray, 2015, 56). In addition, the
government failed in its quest to tackle poverty and inequality by providing handouts to
minorities.
The Negative Income Tax Experiment
The negative income tax (NIT) experiment was a proposed replacement for the welfare
system with the hope of benefitting low-income families. Individuals whose income fell below a
certain threshold received payments from the government to supplement their income (Murray,
2015, 149). The NIT contrasts with the standard income tax we have today where citizens pay
taxes to the government, with NIT the flow of money is from the government to people with low
incomes. Murray highlights the major concern of the conservatives, moderates, and working-
class who rightfully so saw the NIT as a welfare giveaway.
The negative income tax carried work disincentives as any welfare program (Murray,
2015, 149). People naturally get used to receiving handouts and aren’t motivated to find jobs,
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keep them, or do the bare minimum due to the guaranteed income flow. However, work
incentives of positive tax programs are analyzed by comparing their effects relative to no tax
program at all, the work incentive of a negative income tax is generally judged by a comparison
of their effects relative to a welfare program with a so-called 100% tax rate (Moffitt, 2003, 119).
The government provides benefits to low-income families, and gradually reduces the amounts of
benefits or income tax payment they receive as their earned income increases.
Murray believed that supporters of NIT minimized its effects on work incentives. The
most evaluated experiments were recorded in Seattle and Denver Income Maintenance
Experiment (SIME/DIME) from 1971 to 1978. As represented by the SIME/DIME, desired work
hours were reduced by 9 percent for husbands and 20 percent for wives (Murray, 2015, 151).
Murray explains that the 9 percent reduction in work hours for husbands wouldn’t have been
significant if those lost hours were due to husbands volunteering to work a few hours less to
make time for other worthy pursuits. But he specified that the lost hours consisted of husbands
who had opted out of the labor market completely hence reducing the probability of entry into
employment (Murray, 2015, 151).
Furthermore, the results for husbands weren’t as concerning as they were with wives and
young males who were not yet heads of families. As Murray puts it, for some families, the
incomes generated by wives was the significant push they needed out of the poverty hole. The
role of wives cannot be ignored especially starting from the Second World War. Hence a 20
percent loss in work hours is a significant figure in a family’s status in the society. On the other
hand, young unmarried men who are at a critical stage of their lives in terms of making a name
for themselves in the labor force and probably thinking about starting their families showed a
massive reduction in work hours.
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According to Murray (2015), “the NIT had a disastrous impact on their hours of work per
week;43 percent for those who remained nonheads throughout the experiment and 33 percent for
nonheads who married” (151). As much as excuses could be made regarding whether this
decrease in hours may be because of temporary effects such as college, investigations revealed
that the percentage in loss became stronger in the five -year experiment than the three-year
experiment confirming that it wasn’t a temporary effect (Murray, 2015, 152).
Friedman and Murray both share some contradictory views regarding the negative
income tax. Friedman shared the view that the NIT needed the support of both the right and left
in a no-ideal world where; the NIT replaced many counterproductive welfare measures and
where private charity could not be counted on to solve the needs of the poor (Pries, 2015, 181).
Murray and Friedman both support the claim that a basic income will aid liberal societies to meet
the basic needs of all citizens, without manipulating the role that price mechanism plays in
efficiently allocating resources, as welfare state programs appear to (Pries, 2015, 181).
Murray points out the fact that the failures of the state regarding NIT was mainly because
of the lack of a pure control group. The control group used were made up of a population already
receiving welfare benefits and the idea of receiving extra benefits (money) boosted the numbers
of the NIT experiment (Murray, 2015, 153). He further argued that the work disincentives, fewer
hours worked, and extensive unemployment periods during the NIT experiment superseded those
of the already implemented welfare system that the NIT sought to either improve or replace
(Murray, 2015, 153).
In addition, Murray believed that the results of the NIT weren’t a direct representation of
the population and or the program. He explained, the fact that payments were guaranteed for at
least the next three-year period ensured that participants complied with most of the requirements
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to ensure that they received their benefits. Obviously, the longer the commitment, the greater the
negative results of the NIT. As Murray puts it, “people are less likely to burn bridges behind
them if they know that the guaranteed income ends in three years than if it is legislated for life
(Murray, 2015, 153). The NIT had significant effects on important sectors of our society; work,
family, welfare programs, etc. but most importantly, these effects be in positive or negative
continue to shape the welfare system we have today in our quest to find the perfect answer to the
seemingly never-ending poverty dilemma.
Maximizing Short Term Gains
The caseloads of Aid to Families with Dependent Children (AFDC) recorded an overall
increase of 7 percent in the 1950s, the number tripled in the timeframe of 1960 to 1965 to 24
percent and a 125 percent increase in caseload was recorded from 1965 to 1970 (Murray, 2015,
166). The percentage change in the caseloads can be attributed to either economic conditions,
family structures, immigration, and changes in the eligibility requirements.
The welfare system showcased a bias against marriages in the sense that, AFDC benefits
were presumed to be only provided to divorced, separated, never-married, singles, and single
moms (Moffitt, Reville, & Winkler, 1998, 259). These presumptions were informally accurate in
the sense that the eligibility requirements in the ’50s and early ’60s was not in favor of families
having husbands in the homes and receiving benefits (Murray, 2015,160). This goes against the
Biblical Christian view of the American society where young males and females were
encouraged to get married and stay married rather than engage in adulterous acts and having
children before marriage.
The time period of the 1960s to the 1970s was an era that kickstarted the changes in
AFDC. In 1961, laws were passed to allow payments to families with an unemployed father
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which was adopted by 25 states (Murray, 2015, 162). Furthermore, in 1966, the Department of
Health, Education, and Welfare forbade unannounced visits to homes to check their eligibility.
The other two key changes were; eliminating man-in-the house eligibility restriction and the
thirty-and-or third. These four major changes helped boost the number of caseloads, this is
because it increased the number of eligible members.
As explained by Murray, the changes mentioned above provided an incentive to work for
women and families already receiving benefits especially in the thirty-and-a third rule (Murray,
2015, 163). The state was focused on temporary gains and failed to notice that the same rule
carried a negative response of attracting women who were not on welfare to apply for benefits
hence increasing the caseload (Murray, 2015, 163). In an economic sense, as the thirty-and-a-
third rule allowed women on welfare to earn income while receiving benefits, the supply of
women in need of welfare benefits increased (Murray, 2015, 163).
The biblical model of government and statesmanship
Our Christian faith teaches us that we are made in the image of God. The lord’s nature
unarguably is love, mercy, humble and He teaches us to love our neighbors as we love ourselves.
The biblical model of government affirms limited government, it affirms free market, it affirms
non-centralization it affirms that the church has certain responsibilities that the state can never
reproduce. (Fisher, 2019). The welfare state sought to satisfy this Christian value, in the sense of
helping the needy.
In the Biblical days, the Kings and the wealthy were expected to care for the people.
Those who defied the Lord's word were rebuked and hence fell short of the glory of God.
According to Spivey (2013), “social justice was a universal duty, sabbatical, jubilee, and other
poor relief laws applied to all Jews but was not limited to Jews” (Spivey, 2013, 49). The state and
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the church differ in the sense that they are not bound by faith in a higher being. As the church is
held accountable openly by God Almighty, the state is accountable to its people and hence enjoys
the freedom of picking and choosing with benefits are offered and in which terms. It goes
without mention that; churches have always substituted the state in providing for the needy.
Churches usually provide services that aren’t provided by the state and are guided by less strict
guidelines (Hungerman, 2005, 2245).
The AFDC eligibility requirements before 1968 restricted eligibility to single-parent
families. This left women with a tough decision to make; get married and lose welfare benefits or
being unmarried and get on welfare (Moffitt, Reville, & Winkler, 1998, 259). The Holy Bible
speaks to us about marriage as a gift from God and as such we must cherish it. In Matthew 19: 4-
6 it says, “a man shall leave his father and his mother and hold fast to his wife, and the two shall
become one flesh, so they are no longer two but one flesh. What therefore God has joined
together, let not man separate” (ESV). As humans, it is very easy to be swayed by worldly things
such as money, fame, etc. Any woman in the timeframe where AFDC benefits were dependent on
the family structure would think twice about marriage if it meant she may lose her welfare
benefits.
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