Chapter Outline

Regulating the Economy

1. Adam Smith favored a laissez-faire economy which holds that private individuals and firms should be left alone to make their own production and distribution decisions. His theory included the concepts of demand, supply and profit. Government should regulate natural monopolies such as banking, currency and contracts and give stability to private transactions.
2. Karl Marx criticized Smith's free-market system as exploitive of workers and proposed a worker-controlled economy. He proposed a collective economy based on the assumption that if workers owned the means of production, the economy would operate in the interest of all people and not just the owning class.
3. Most national economies today are neither purely laissez-faire nor collectivist but are "mixed," which means that they contain some elements of both private and public control.

The U.S. government plays a substantial role in the economy through regulation of privately owned businesses. Regulatory policy is intended to promote either economic efficiency or equity.

1. The goal of efficiency is to fulfill as many of society's needs as possible while using as few of its resources as possible. Efficiency dictates that government act to prevent restraint of trade and make business pay for indirect costs.
1. Beginning in the 1960s, government initiated a system of regulation to require businesses or customers to cover previously unpaid costs (externalities). An example is the Clean Air Act. Too much regulation can be a source of inefficiency.
2. Deregulation is a response to too much regulation. It rescinds regulations already in force for the purpose of improving efficiency. An example is the Airlines Deregulation Act.
2. A challenge for policymakers is to strike a proper balance between regulatory measures and free market mechanisms.
3. Government can intervene in the economy to assure that an economic transaction is fair to each party (equity). Examples of government intervention to promote equity are the establishment of the Food and Drug Administration and the Fair Labor Standards Act.
4. Economic regulation in America has occurred as national conditions have produced intermittent bursts of social consciousness.
1. In the Progressive era, reformers sought to break the power of trusts.
2. In the New Deal era, reformers sought to stimulate economic recovery.
3. In the 1960s and 1970s, regulation followed a social agenda in the areas of environmental protection, consumer protection and worker safety.

Government As Protector of the Environment

1. The government land conservation policies began in the 1870s with policies creating the national park system. National parks and forests are managed under a "dual use" policy which permits private business to use some federal resources.
2. The latest wave of environmentalism has resulted in public participation in policy to protect air, water, and other pollutants.
3. Creation of the U.S. Environmental Protection Agency in 1970 gave increased impetus to government regulation of pollution thus provoking conflicts between business and environmental protection priorities.

The U.S. government makes important contributions to business, labor and agriculture.

1. Business interests have been promoted by government regulation of the public air waves, tax credits for capital investments and depreciation, loans and loan guarantees. Business is especially aided by contributions government makes in the areas of education, transportation and defense.
2. Labor benefited somewhat from the National Labor Relations Act of 1935 which allowed workers collective bargaining but also passed the Taft-Hartley Act of 1947 which prohibited compulsory union membership. Labor has been helped by government legislation establishing minimum wages and maximum work hours, unemployment benefits, safer and more healthful working conditions and nondiscriminatory hiring practices.
3. Agricultural policy is designed to stabilize farmers' income and provide emergency assistance. In 1996, Congress phased out nearly all price support policies through the Federal Agricultural Improvement and Reform Act.

Government As Promoter of Economic Interests

Fiscal policy involves government management of taxing and spending policies to maintain a stable economy.

1. The annual federal budget is the foundation of fiscal policy.
2. Changes in spending and taxing are means of keeping the economy's normal ups and downs from become extreme.

Types of fiscal policy include demand-side economics and supply-side economics.

1. Demand-side economics places more money in consumer's hands so they can buy more goods and services. This increased demand stimulates production and employment. Demand-side economics tends to increase government spending and is a less attractive policy when the national debt is high.
2. Supply-side economics places more money in the hands of businesses by providing business tax cuts and incentives that encourage firms to expand production, thus creating jobs and enlarging supply, each of which can stimulate consumer demand. Money is supposed to "trickle- down" to benefit lower income sectors, but in the 1980s, supply-side economics (Reaganomics) chiefly benefited businesses and upper- income individuals.
3. Government also tries to regulate inflation rates by reducing its spending or by raising personal income taxes to reduce the amount of money consumers have to spend.

The chief actors in determining fiscal policy are the president and Congress interacting through the budgetary process.

1. The president, assisted by the Office of Management and Budget, proposes the federal budget based on government's projected revenues from taxes and borrowed funds.
2. The House and Senate Appropriations committees review and revise the president's budget based on figures from the Congressional Budget Office. Differences are reconciled in conference committees and sent to the president for approval or veto.
3. Determination of fiscal policy is a political process with the Democratic and Republican parties differing about which elements to emphasize. The Democrats prefer to reduce joblessness while the Republicans usually want to reduce inflationary pressures. Democrats tend to favor a progressive tax system while Republicans tend to favor lower taxes on wealthier individuals in hopes of encouraging savings and investment that foster economic growth.
4. The economic health of the nation can influence voter preferences; the electorate tends to hold the president's party responsible for the state of the economy.

Monetary policy is based on management of the amount of money in circulation to either achieve low productivity and high unemployment (slowing the economy) or to achieve excess productivity and high inflation (invigorating the economy).

1. The Federal Reserve System led by the Federal Reserve Board determines monetary policy by lowering or raising interest rates charged on money borrowed from the Federal Reserve by its member banks.
2. The Fed also affects the money supply by selling and buying government securities in the open market.
3. The Fed can raise or lower the cash reserves that member banks are required to deposit with the Federal Reserve Bank in order to regulate the amount of money in circulation.
4. The Federal Reserve Board can act independently of other sectors of government in protecting moneyed interests, thus raising questions about its accountability.