Economic Policy Institutions and the Budget Process

Economic Policy Institutions:

Monetary policy in the United States is prepared by the Federal Reserve which is our central bank. In other countries the central bank stands for a different name. The most general is the name of its country: the central bank of country X is most likely named "The Bank of X."

The principal policy-making body of the Federal Reserve System is its FOMC (Federal Open Market Committee). It is the FOMC that lowers and increase interest rates and that increases and decreases the money supply. The Federal Reserve's Board of Governors can vary bank regulations and can and elevate or lower the interest rate at which the Federal Reserve itself lends to banks and businesses. However most of the time it is the FOMC that plays the leading role within the Federal Reserve.

Today the Federal Reserve is the most significant organization making macroeconomic policy. For the reason that monetary policy is the most powerful tool for stabilizing the economy, the Federal Reserve plays the leading role in stabilization policy. Fiscal policy plays second swindle. This institutional division of labor is most likely the correct one. Over the past 50 years in the United States monetary policy has shows itself to be more faster-acting, powerful and more reliable than fiscal policy.

The Federal Reserve:

The Federal Reserve has a central office as well as twelve regional offices. Its central office is the Board of Governors encompasses of a Chair, a Vice Chair, and five Governors all of them designated by the President and confirmed by the Senate. The Board of Governors' offices are in Washington D.C.

The Federal Reserve’s twelve regional offices are the twelve Federal Reserve Banks. They are spread around the country. There are Federal Reserve Banks in Kansas City, St. Louis, Chicago, Cleveland, San Francisco, Minneapolis, Dallas, Atlanta, Richmond, Philadelphia, New York, and Boston.

The members of the Board of Governors as well as the Presidents of the twelve regional Federal Reserve Banks meeting together make up the FOMC [Federal Open Market Committee], which is the principal policy-making body. The Chair, the Vice Chair, the other five Governors and the President of the Federal Reserve Bank of New York are for all time voting members of the FOMC. The eleven Presidents of the other Federal Reserve Banks alternate at any moment four of them are voting members and seven of them are non-voting members of the FOMC.

The Federal Reserve was created just prior to World War I. Its Congressional architects feared that a unitary central bank base in Manhattan would pay too much attention to the interests of bankers and financiers and not adequate attention to the interests of merchants and producers. A near-century of experience nevertheless suggests that they were wrong: bankers in St. Louis think akin to bankers in New York.

The Federal Reserve failed to manage its first great crisis the Great Depression that started in 1929. Depending on whom you believe the Federal Reserve either did nothing to help cure the Great Depression or it made things much worse and played a major role in causing the Great Depression. Since World War II nevertheless the Federal Reserve has done a much better job- there has been no repeat of the Great Depression.

The Federal Reserve's performance in the 1970s is usually regarded as inadequate. The 1970s were a decade of increasing inflation and relatively high unemployment. Today, subsequent to two straight decades in the 1980s and 1990s of extremely successful monetary stabilization policy the prestige of the Federal Reserve is high. It has approximately unlimited freedom to conduct monetary policy as it wishes. Little outside the organization wish to challenge its judgments or decisions.

The FOMC tries to achieve its decisions by consensus. If a consensus can’t be achieved the members of the FOMC are more probable to postpone the issue than to make a decision that some substantial minority of its members oppose. Nevertheless once the FOMC decides on a change in policy that change is implemented immediately. It takes merely minutes for interest rates to shift in response to FOMC decisions. Indeed frequently interest rates will change in advance of the actual FOMC meeting as speculators attempt to make money by betting on what they believe the Federal Reserve will do.

The FOMC changes interest rates by moving out open-market operations. In an expansionary open-market procedure the Federal Reserve buys government bonds. Such a transaction decreases the amount of interest-bearing government bonds available for investors to hold. This reduction in supply increasew the price of short-term government bonds--and an increase in the price of a bond is a decline in its interest rate. When the Federal Reserve purchase government bonds it pays for them by crediting the purchasers with deposits at the regional Federal Reserve banks. Commercial banks utilize these deposits to satisfy the reserve requirements imposed on them by bank regulators. The additional reserves a bank has the more deposits it can accept as well as the more loans it can make. With more banks annoying to make more loans the interest rates that banks charge on loans drop. Therefore purchases of government bonds by the Federal Reserve are expansionary open-market operations and lower interest rates. Contractionary open-market procedure work in reverse and raise interest rates.

Open market operations aren’t the only policy tools the Federal Reserve has. The Board of Governors can change legally-required bank reserves. The Board of Governors can loan money straight to financial institutions. However these are used very rarely. Roughly always the FOMC can utilize open-market operations to set interest rates at whatever it wants them to be.

Note the ‘almost always’. There is merely one important restriction on the Federal Reserve's power to set interest rates. The Federal Reserve can’t reduce the nominal interest rate on any Treasury securities lower zero. If a Treasury bill approved an interest rate less than zero, then no one would want to purchase it: it would be more profitable to merely hold cash instead.

It is possible to imagine situations in which this inability of the Federal Reserve to push nominal interest rates below zero has destructive consequences. If prices are expected to fall -- if it is a time of anticipated deflation therefore that the expected inflation rate is negative--a nominal interest rate that is close to however not less than zero may still be a relatively high real interest rate because the real interest rate r is the difference between the nominal interest rate i and the expected inflation rate πe.

r = i - πe

If the expected inflation rate is adequately far below zero the real interest rate will be high and investment low no matter what the FOMC does.

Fiscal policy in the United States today is supervised by the Congress (subject to the veto of the President). The Congress pass laws which the President then signs (or vetoes--and the Congress then overrides or fails to override the vetoes). The Congress's tax laws figure out the taxes imposed by the Federal Government. The Congress's spending bills figure outs the level of government purchases. Mutually these taxes as well as government purchases make up the government's fiscal policy.

The Budget Process:

1887_budget process.jpg

Legend: The process by which the Congress as well as the President make fiscal policy is arcane and byzantine.

A few broad classes of expenditure called mandatory are the result of open-ended long-term government commitments and continue whether or not Congress explicitly appropriates money for them in the current year. Medicaid, Social Security, Medicare, unemployment insurance, food stamps, and so forth fall into this category of so-called mandatory spending. Other broad classes of expenditure, called discretionary, should be explicitly appropriated by Congress in each fiscal year. Defense spending, NASA, the National Park Service, the National Institutes of Health, highway spending, education spending and so forth fall into this category of so-called "discretionary" spending.

Early in one fiscal year the Executive Branch departments as well as agencies that administer federal programs begin planning for the next. During the fall they negotiate with the President's Executive Office--the Office of Management and Budget. The end of these discussions modified by the President's own priorities becomes the President's budget submission to the Congress in January.

The Congress considers the President's budget ask for conducts its own internal debates and by the end of April is supposed to have passed a budget resolution giving spending targets for broad classes of expenditure. Utilizing the budget resolution as a guide the Congress alters and amends the laws that control mandatory spending alters and amends and tax code and passes the appropriations bills necessary for discretionary spending. By the end of September all of the misuses bills are supposed to have been passed consequently that the new fiscal year can begin with the pieces of the government knowing what and how much should be spent over the next twelve months.

More frequently than not nevertheless Congress fails to pass or the President vetoes one or more appropriations bills. In that case the government carries on more-or-less on autopilot if the Congress passes and the President signs a continuing resolution until the appropriations bill is passed. If they do not the government shuts down. Discretionary spending is slash back to the bone. Unneeded employees are sent home. The Washington Monument as well as other major tourist attractions are closed. Government office buildings are inhabited by only a skeleton crew of key functionaries and unpaid interns until the Congress and the President Reach agreement and pass and sign the appropriations bills necessary for the government's discretionary spending programs to go forward.

Nevertheless even during a government shut down most of what the government does continues. Mandatory spending doesn’t have to be explicitly appropriated every year and continues even if there is total gridlock in Washington.

The lesson to draw from this overview is that making fiscal policy in the United States is baroque, complicated, and time-consuming. The insides lag--the time between when a policy proposal is made as well as when it becomes effective--for fiscal policy is measured in years. By contrast the inside lag connected with FOMC-decided changes in monetary policy is measured in days-weeks-or at most two months. The FOMC is able to turn on a dime. The Congress as well as the President cannot. This is a major advantage that makes the Federal Reserve more effective at undertaking stabilization policy to manage aggregate demand.

The History of Economic Policy

The government didn’t always see itself as being responsible for stabilizing the economy and taming the business cycle. It accepted this accountability in the Employment Act of 1946 which:

a) Recognized Congress’s Joint Economic Committee.

b) Recognized the President's Council of Economic Advisers.

c) Called on the President to estimate as well as forecast the current and future level of economic activity in the U.S.

d) Announced that it was the continuing policy and responsibility of the federal government to coordinate and utilize all its functions, plans and resources. to foster and promote free competitive enterprise as well as the general welfare conditions under which there will be afforded helpful employment for those willing and able and seeking to work and to promote maximum production, employment and purchasing power.

Passage of the Employment Act marked the rout of the conviction that the government couldn’t stabilize the economy and shouldn’t try to do so. In this view monetary and fiscal policies to fight recessions would keep workers and firms producing in unsustainable lines of business and levels of capital intensity and would make the depression less deep only at the price of making it longer.

This doctrine that in the long run even profound recessions like the Great Depression would turn out to have been ‘good medicine’ for the economy drew anguished cries of dissent even before World War II. John Maynard Keynes attempted to ridicule this ‘crime and punishment’ view of business cycles concluding that he didn’t see how ‘universal bankruptcy could do us any good or bring us any nearer to prosperity’ Indeed it was largely due to Keynes's writings, particularly his General Theory of Employment, Interest and Money that economists as well as politicians became convinced that the government could halt depressions and smooth out the business cycle. However Keynes wasn’t alone. For instance Ralph Hawtrey an advisor to the British Treasury and the Bank of England entitled it the equivalent of ‘crying, 'Fire! Fire!' in Noah's flood.’ However you still can see traces of this view in economics in places (like the real business cycle theories).

The high water mark of self-reliance that the government could and would manage to use its macroeconomic policy tools to stabilize the economy came in the 1960s. In that decade President Johnson’s chief economic consultant Walter Heller wrote of the New Dimensions of Political Economy that had been opened by the Keynesian Revolution. The Department of Congress unlearned the title of its Business Cycle Digest to the Business Conditions Digest--because after all the business cycle was dead.

The 1970s nevertheless erased that confidence. Economists Milton Friedman as well as Edward Phelps had warned that attempts to keep the economy at the upper left corner of the Phillips curve would inevitably cause an upward shift in inflation expectations--that even if expectations had truly been static during the 1950s and early 1960s they would become adaptive if unemployment were pressed too low for too long. Friedman with Phelps were correct- the 1970s saw a sharp upward shift in the Phillips curve as people lost confidence in the commitment of the Federal Reserve to keep inflation low and raised their expectations of inflation. The consequence was stagflation- a combination of relatively high unemployment as well as relatively high inflation. The lesson erudite was that attempts to keep unemployment low and the level of output stable were counterproductive if they eroded public confidence in the central bank's commitment to keep inflation low and prices stable.

The 1970s ended with several economists convinced that activist monetary policy did more harm than good and that the United States might be better off with an automatic monetary policy that fixed several control variables like the money stock to a stable long-run growth path. However the sharp instability of monetary velocity since the start of the 1980s has greatly reduced the number of advocates of such an automatic central bank that lets the money stock grow by a fixed proportional amount in every year.

Latest technology based Macroeconomics Online Tutoring Assistance

Tutors, at the, take pledge to provide full satisfaction and assurance in Macroeconomics help via online tutoring. Students are getting 100% satisfaction by online tutors across the globe. Here you can get homework help for Macroeconomics, project ideas and tutorials. We provide email based Macroeconomics help. You can join us to ask queries 24x7 with live, experienced and qualified online tutors specialized in Macroeconomics. Through Online Tutoring, you would be able to complete your homework or assignments at your home. Tutors at the TutorsGlobe are committed to provide the best quality online tutoring assistance for Macroeconomics Homework help and assignment help services. They use their experience, as they have solved thousands of the Macroeconomics assignments, which may help you to solve your complex issues of Macroeconomics. TutorsGlobe assure for the best quality compliance to your homework. Compromise with quality is not in our dictionary. If we feel that we are not able to provide the homework help as per the deadline or given instruction by the student, we refund the money of the student without any delay.