AP Gov — Economic Policy Test

Keynesian economics

Theory based on the principles of John Maynard Keynes, stating that government spending and interference should increase during business slumps and be curbed during booms.

Why did the banks give so many people who couldn't afford it mortgages?

They thought they were beyond risk because of how the housing market had been continually increasing

What were the 5 financial bombs that Geithner told the President Obama needed to be defused at their first meeting?

They were 5 massive financial institutions that were in serious danger of failing because they had overleveraged themselves. Those institutions were: Fannie Mae, Freddie Mac, AIG, Citigroup, and Bank of America

What does income tax being progressive mean?

Those with more income pay higher rates of tax on their income.

supply-side economics

Trickle-down economics. Lower tax rates especially for the wealthy (likely to invest) and the benefits will trickle down to the working class

The balanced budget act of 1997

Under Clinton: Legislation intended to reduce Medicare spending, create incentives for development of managed care plans, encourage enrollment in managed care plans, and limit fee-for-service payment and programs

Stagflation

a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation)

federal budget

a plan for the federal government's revenues and spending for the coming year. How the US Government will be allocating burdens (taxes) and benefits (expenditures).

federal debt

all the money borrowed by the federal government over the years and still outstanding (~$30T)

excise tax

tax on luxury items

OPEC

the Organization of Petroleum Exporting Countries, a group established in 1960 by some oil-producing nations to coordinate policies on selling petroleum products. Stopped selling oil to US in early '70's b/c US supported Israel over its neighbours

open market operations

the buying and selling of government securities (bonds) by the Fed to alter the supply of money

3 Policies of supply side economics

1) Cut taxes 2) Lower Spending 3) Less Regulations

4 examples of tax expenditures

1) Deduction for Charitable Contributions 2) Child Tax Credit 3) Tax exclusion for Employer Contributions to Medical Insurance Premiums 4) Interest on your mortgage payment

Total cost of financial system bailout?

$350B +

HW Bush's Fiscal Policy

- "Read my lips: no new taxes." - Reagan's deregulation of banks led to 700 Savings & Loan banks failing; US taxpayers paid billions to bail out S&Ls (FDIC) - Mid-1990, US enters a recession (Unemploy=7.3% - Bush signs 1990 Budget Enforcement Act: raised taxes despite no new tax pledge and enacted PAYGO (raised taxes or cut other programs for any new programs) - By end of Bush's term: recession had ended

Nixon's Fiscal Policy

- '69-70 Recession: inflation rose (5.84% by '71), unemployment: up to 6.1% (start of stagflation) - So, Nixon issued an Executive Order: 90 Day Wage-Price Freeze in order to counter inflation which failed - He took the Dollar off the gold standard - OPEC nations started oil embargo; oil prices quadrupled - Nixon & Congress raised tax on oil, built Alaskan pipeline and lowered speed limits to 55 MPH - By Nixon's resignation: Unemployment at 5.6%, inflation 12%, deficits rising

Strategic Defense Initiative (SDI) aka Star Wars

- A missile-defense system project under Reagan that called for orbiting battle satellites in space that could fire laser beams to shoot down intercontinental missiles. - Lot of money went into it but it never worked - However, bankrupted Soviets as they tried to keep up and caused the collapse of the USSR

Why did the government save Bear Stearns?

- Bear had appealed to Geithner at the Fed to save them, but he was initially inclined to let them go under - Then Geithner found how many credit default swaps Bear had so if it went under, many others would follow because of how much money they had invested in Bear

How did Paulson use capital injection?

- Called heads of 9 largest banks to treasury and forced them all to take the money

Clinton's Fiscal Policy

- Candidate Clinton promised middle class tax cuts, healthcare reform & gov't stimulus program - Before inauguration met with Fed Chairmen Greenspan: learned that long term interest rates too high because the Bond traders demand higher interest rates due to gov't deficits which caused growing inflation. - Greenspan told Clinton: show seriousness about deficit & inflation, long term interest rates will decrease - Demand for homes/mortgages, consumer spending & stock prices will increase, unemployment decrease - Clinton did as told, went back on promises, raised taxes, lowered spending, ended up w/ budget surpluses - Welfare Reform passed Congress, signed by Clinton - 1997 Budget Deal with GOP Congress: tax increases and spending cuts - Created North American Free Trade Act (NAFTA) - By end of Clinton's term: unemployment rate down to 3.9%, inflation rate under 3%, 3 consecutive budget surpluses ($69B, $125B, and $250B) and stock market booming!

Why did the government loan to AIG after refusing to loan for the Lehman Brothers acquisition?

- Country's largest insurance company - Had a ton of credit default swaps - B/c Lehman went bankrupt, had to pay insurance - Couldn't get loans b/c credit market was frozen - Considerably more interconnected then other - Government took 80% control over AIG through lending

guns or butter

- Generally a president spends on one or the other. - Guns = defense - butter = Social spending - LBJ spent on both (Vietnam and Great Society)

Reagan fiscal policy

- Inherited a recession: By 1982 (2nd year in office) unemployment up to 10.7% and inflation rate still going up and interest rates were 16.5% - Supply-side fiscal policy called Reaganomics: - Massive cut of gov't regulation of business - Huge tax cut (25%), biggest cuts to wealthiest - Cut social spending but 25% increase in defense (SDI or "Star Wars") - USSR bankrupted trying to keep up (end of Cold War), but annual deficits growing ($270B)

LBJ's Fiscal Policy

- Johnson believed that he didn't have to choose between guns and butter. He thought that he could have them both. Result: an excess in borrowing and spending. "Guns and Butter" • Results of LBJ's fiscal policy: unemployment falls to under 4%, inflation rose to 5.5% and the deficits nearly tripled from $8.7B to $25B

Why did the government take control of Fannie Mae and Freddie Mac?

- Largest mortgage holders in the US - Held $5T in mortgages - Caused panic because two of the largest companies could fail - If they went under it would be catastrophic for the market - Government took them over to save them and injected money into it—Government became largest shareholder

Monetary Policy in Great Recession

- Led by Ben Bernacke - Followed an expansionary monetary policy: - cut interest rates down to 0 by 2008, bought bonds (open market operations) injecting $4.5 trillion into US economy from 2008 - 2014 - Recession ended in 2010; Fed stops buying bonds (open market operations) in October 2014

Why did Paulson let Lehman Brothers go under? What was the result?

- Paulson had bailout exhaustion and was under immense political pressure not to - Because of moral hazard, thought that Lehman had to go under as an example - As a result, markets crashed due to systemic risk - Loaning stopped because banks couldn't borrow money - Credit market froze, commerce started to stop

top 4 federal expenditures

1) Entitlements 2) Defense 3) Non-defense Discretionary 4) Net Interest of Debts

Top 4 sources of Federal Revenue (Taxes)

1) Income Tax 2) Payroll 3) Corporate 4) Excise

W Bush's Fiscal Policy

- Return to supply-side economics... sort of - Cut gov't regulations, cut taxes, but increased spending: two wars ($795B), passed Medicare Part D (prescription drug costs= $850B/10 years) - By 2007, housing bubble burst; housing prices fall - By 2008, start of Great Recession (worst since '33) - Bush signed Emergency Economic Stabilization Act of 2008 which injected $700B into US banks - By end of Bush's term: unemployment, 7.3%, inflation, -.4% (deflation) and huge deficits

Monetary Policy during Reagan's presidency

- Run by Volker at first - While Reagan followed supply-side economics, the Fed begins a contractionary monetary policy - Raised interest rates up to 21.5% by 1982 - Results: By 1984, inflation went down to 4%, but unemployment rose to 10.7% - Once inflation came down in '84, the Fed lowered interest rates (expansionary policy) and unemployment began to dropped to 7%

Carter's Fiscal Policy

- Social Security was going bankrupt; so he raised SS taxes (biggest hike ever!) - Stimulus spending program created jobs in private sector - Cut govt spending: cut gov't jobs, eliminated govt waste, - Oil prices rising! (During 70s, US oil bill rises: $1.5B/yr to $60B/yr) - By 1980, interest rate is at 20% (Volker): results in drop offs in retails sales, home construction and purchases of existing homes, and other industries hurt: autos (Chrysler declares bankruptcy) - By end of Carter presidency: Unemployment is 7.5%, inflation rate 13.5% (stagflation) The annual deficit climbed to $79B.

What does the US government borrow money?

- The Treasury Department sells bonds - The government competes with other lenders. - Unlike taxes, this must be paid back.

What has caused the rise of social service state spending?

- The biggest part of federal spending is now for income security programs. - The biggest of these is Social Security. - Social Security has been expanded since 1935 to include disability benefits, Medicare and part of Medicaid costs. - These benefit programs face financial problems with more recipients living longer (baby boom generation)

Why did Bear Stearns go out of business?

- Were the smallest bank on Wall Street - Had been packages mortgages into securities like a lot of others - Had borrowed money to buy stocks - There were rumours that they had run out of cash so people started pulling money out and there stock was in free fall - They struggled to pay back their loans because no one would loan to them - Bear also had way too many of these - Only option = appeal to Fed

Payroll tax/social insurance tax (FICA)

7.65% of payroll goes to Medicare/Medicaid & Social Security not general revenue. Maximum limit on earnings for withholding of SS was $137,700 in 2020 Known as the Federal Insurance Contributions Act

fiscal year

A 12-month period, October 1st through September 30th, in which a federal budget is effect

What is a continuing resolution (CR)?

A continuing resolution is a temporary funding measure that Congress can use to fund the federal government for a limited amount of time by continuing funding at the current levels

Medicare

A federal program of health insurance for persons 65 years of age and older

sub-prime mortgages

A type of mortgage that is normally made out to borrowers with lower credit ratings.

ARRA

American Recovery and Reinvestment Act : In 2009, the Obama Administration signed the American Recovery and Reinvestment Act (ARRA) or Stimulus Package into law. It contains billions of dollars in funding for science, engineering research and infrastructure, as well as funding for education, social sciences and the arts. Its greatest relevance to informatics is its major investment in the implementation of electronic health records and support for comparative effectiveness research.

deficit

An excess of federal expenditures over federal revenues.

expansionary fiscal policy

An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output

capital injection

An investment of capital generally in the form of cash or equity - and rarely, assets - into a company or institution, in this case by the government into the banks

5th source of money for the government?

Bonds

Timothy Geithner

Chair of NY Federal Reserve at start of Great Recession. Treasury Secretary under Obama

Ben Bernanke

Chairman of the Federal Reserve during Great Recession

Who was the last president to run a surplus?

Clinton

non-defense discretionary spending

Everything else (eg. transportation, energy, healthcare, education)

What branches of the US Gov't conduct fiscal policy?

Executive, Legislative

Credit Default Swap

an insurance policy on the default risk of a corporate bond or loan

Examples of Keynesian policies

FDR's New Deal programs such as Works Progress Administration (WPA); TARP, ARRA, cash for clunkers during the 2008 financial crisis and Great Recession

When does the budget process begin?

February

contractionary monetary policy

Federal Reserve actions to decrease the money supply via raising interest rates, raising reserve requirements, and selling bonds

expansionary monetary policy

Federal Reserve actions to increase the money supply via lowering interest rates, lowering reserve requirements, and buying bonds

Medicaid

Federal program that provides medical benefits for low-income persons.

contractionary fiscal policy

Fiscal policy used to decrease aggregate demand or supply. Deliberate measures to decrease government expenditures, increase taxes, or both. Appropriate during periods of inflation.

Moderate Economic Policy

George HW Bush, Clinton

Typical Keynesian Presidents

LBJ, Obama

When should expansionary monetary and fiscal policies be used?

Low Inflation, High unemployment

entitlements

Mandatory government spending (e.g., Social Security, Medicare/Medicaid, SNAP, unemployment insurance)

Great Society Programs

Medicare, Medicaid, Housing and Urban Development Act of 1965, Headstart, War on Poverty

Defense expenditures

Military spending (eg. paying for soldiers, their equipment housing etc., maintenance of weapons cost, R&D)

monetary policy

Monetary policy is a set of actions available to a nation's central bank to achieve sustainable economic growth by adjusting the money supply.

Works Progress Administration

New Deal agency that helped create jobs for those that needed them. It created around 9 million jobs working on bridges, roads, and buildings.

Which president in recent year did the most deficit spending?

Obama

"Read my lips: no new taxes"

Promise from HW Bush not to raise taxes but was forced to in order to reduce deficits spending What did Bush Sr say when campaigning for president in 1988 that came back to haunt him in the 1992 campaign for re-election after he broke this promise

Housing and Urban Development Act of 1965

Provided federal funds to cities for urban renewal and development. For cities to receive the funds, they had to establish minimum housing standards.

Typical Supply-sider presidents

Reagan, Bush, Trump

What are tax expenditures?

Revenue losses that result from special exemptions, exclusions, or deductions on federal tax law. Important because they allow the government to promote their policy goals such as decarbonisation.

Henry "Hank" Paulson

Secretary of Treasury under GW Bush, involved in several different multi-billion bailout packages, worked for Goldman Sachs, has been criticized for being slow to respond to the crisis, and introducing greater uncertainty into the financial markets by letting Lehman Brothers fail.

revenue

Sources of money for the government.

SNAP

Supplemental Nutrition Assistance Program

Tariffs

Taxes on imported goods

Which part of the government conducts monetary policy?

The Federal Reserve

Great Society

The Great Society was a set of domestic policy initiatives, programs, and legislation introduced in the 1960s in the U.S. by LBJ. These Great Society programs were intended to reduce poverty levels, reduce racial injustice, reduce crime, and improve the environment.

TARP

The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was signed into law by U.S. President George W. Bush on October 3, 2008. Way that the government gave money to failing financial institutions to intervene in the entire financial system and it had a price tag of $700 billion

Reaganomics

The federal economic polices of the Reagan administration. Almost Supply side but increased spending particularly on defence (Star Wars)

What happens if the budget deadline is missed?

The government shuts down

The discount (interest) rate

The interest rate on the loans that the Fed makes to banks. Changing it alters banks' borrowing costs and hence the rates that they charge on loans

expenditures

What the government spends money on

surplus

When revenues exceed expenditures

Systematic Risk in the market

When the market is so interconnected that if one company fell, the rest would fall like dominoes

Example of the impact of interest rates

With 30 year mortgages, and interest rate of 6% as opposed to 4% on a $250,000 home leads to an almost $110,000 difference in interest payments

personal income tax

a tax levied on the taxable income of individuals, households, and unincorporated firms—single biggest revenue for government

corporate income tax

a tax on the value of a company's profits

How long does the budget process last?

about 7 months (Until September 30th)

3 Tools of the Fed

changing the discount rate, changing reserve requirements, and conducting open market operations

tax loopholes

exceptions or oversights in the tax law that allow some people and businesses to avoid paying taxes

4 parts of the economic cycle

expansion (recovery), peak (boom), contraction (recession), trough (bust)

When should contractionary monetary and fiscal policies be used?

high inflation, low unemployment

Moral Hazard

lack of incentive to guard against risk where one is protected from its consequences, e.g. by insurance.

Great Recession

severe economic downturn that lasted from late 2007 through mid-2009 caused by 2008 financial crisis

annual deficit

the negative difference between what a nation accumulates in tax revenue and what it spends in any given year

Reserve requirement

the percentage of deposits that banking institutions must hold in reserve

fiscal policy

the use of government spending and revenue collection to influence the economy

Trump's fiscal policy

• Back to supply-side economics again • Cut gov't regulations of business • Major tax cuts • Increased spending (military ,"the Wall" and COVID relief "CARES Act") • Renegotiated NAFTA; now USMCA • As first term ends: unemployment 6.7%, inflation low but deficits increasing • FY 2020 $4.1 trillion deficit

Biden's Fiscal Policy

• Executive Orders on first day in office, including increasing SNAP (Food Stamps) benefits and increased federal workers' minimum wage. • American Rescue Plan - $1,400 stimulus checks, extended unemployment benefits to September, increased child tax credit, pandemic response, aid to state & local goats. • Infrastructure Act: $1.2 trillion , raise corporate income tax to 28% to pay for it, rebuild infrastructure, incl. community-based care for the elderly • By 2022, unemployment low but inflation at 7.4%

Obama's Fiscal Policy

• Inherited Great Recession, return to Keynesian economics • American Reinvestment & Recovery Act (ARRA): stimulus program to pay workers to improve US infrastructure. Total cost: $787B • Kept Bush tax cuts except raised rates for rich (incomes over $200M/year) • Auto industry bailouts for GM, Chrysler & Ford ($50B) • Passed Affordable Care Act (ACA) or Obamacare insured 24 million Americans who lacked insurance (cost $150B) • By end of Obama's term: unemployment rate 4.8%, inflation 2%, national debt doubled