Policy Economics

Policy Economics

Policies are put in place to promote sustainable economic growth by...​

• influencing the supply of money
• influencing interest rates
• support the labor market
• managing taxation

Policy tools influence the economy by easing or tightening financial conditions.

• If the economy is running too cold, policy tools ease financial conditions.
• If the economy is running too hot, policy tools tighten financial conditions.

Policy tools are represented by Monetary Policies and Fiscal Policies.

• Monetary policies are implemented by The Federal Reserve Central Bank
• Fiscal Policies are implemented by U.S Treasury Dept.

Monetary Policy

The Federal reserve can choose to ease or tighten financial conditions through a series of tools. Easing Tools

• Increasing market liquidity by; purchasing commercial bank assets with cash (injecting cash into the system).
• Cutting Interest rates

• Decreasing market liquidity by; selling assets to commercial banks for cash (removing cash from the system).
• Raising Interest rates

• The Fed can add or remove liquidity (buy or sell assets) through Open Market Operations (OMO).

• Assets include U.S Treasuries & Mortgage-Backed Securities (MBS).

• Adding liquidity (injecting cash into the system) consists of the Fed purchasing assets from OMO participants (often commercial banks).
  When the Fed purchases assets from banks they are essentially injecting cash into bank reserves.
• In reverse, the Fed removes liquidity by selling their assets (treasuries and MBS) to commercial banks, essentially removing cash from bank reserves. That access cash goes into the Fed's reserves 

• The FOMC decides to increase or decrease the Federal Funds Rate, the rate it charges commercial banks to borrow from the Fed.
• The Fed Funds Rate sets the rate of interest that banks decide to lend at.
• As the Fed Funds Rate changes, all financial institutions tweak their customer's rates (big businesses, small businesses, home buyers)

Fiscal Policy

• Lowering tax rates
• Increase government spending

• Raising tax rates
• Lowering government spending

• Individuals rates

• Corporate rates

• Infrastructure

• Defense spending 
• Transfer Payments (social security, welfare,  subsidies)​

Balancing Policy

The economy is driven by spending cycles. Up-cycles are expansionary and down-cycles are contractionary. Expansions and contractions are healthy, however unchecked can bring economic chaos. 
Struggling Economy

• falling GDP

• week labor market
• low business activity
• high debt burdens
• decreasing lending/borrowing

Hypothetical Policy Response 
When the economy is struggling to grow, elected officials can ease financial conditions to avoid recession by tweaking policy.

• cut rates

• cut taxes
• increase liquidity 
• job creation through gov spending

Strong Economy

• rising GDP
• strong business activity
• strong labor market
• strong lending/borrowing demand

• steadily rising prices

As the cycle picks back up, policymakers must decide how, when, and where to take their foot off the gas to avoid rampant inflation (elevating prices). If and when inflation becomes persistent, policymakers are tasked with tightening financial conditions without crushing the labor market.
Hypothetical  Policy Response to Inflation

• raise rates
• possibly raise taxes
• reduce liquidity 
• cut government spending

As the cycle turns down, and inflation gets under control, policymakers must decide when enough is enough to avoid plunging the economy into a dangerous recession. If and when a recession hits the economy, policymakers must begin easing financial conditions, reversing the cycle.