What role does the federal government play in influencing the national economy?

How does the Federal Reserve affect inflation and employment?

As the Federal Reserve conducts monetary policy, it influences employment and inflation primarily through using its policy tools to influence the availability and cost of credit in the economy.

Inhaltsverzeichnis Show

How does the Federal Reserve affect inflation and employment?
What role does the federal government play in the economy?
How can the federal government affect the national economy?
How can the federal government influence the economy quizlet?
How does the government use government spending to influence the economy?

The primary tool the Federal Reserve uses to conduct monetary policy is the federal funds rate—the rate that banks pay for overnight borrowing in the federal funds market. Changes in the federal funds rate influence other interest rates that in turn influence borrowing costs for households and businesses as well as broader financial conditions.

For example, when interest rates go down, it becomes cheaper to borrow, so households are more willing to buy goods and services, and businesses are in a better position to purchase items to expand their businesses, such as property and equipment. Businesses can also hire more workers, influencing employment. And the stronger demand for goods and services may push wages and other costs higher, influencing inflation.

During economic downturns, the Fed may lower the federal funds rate to its lower bound near zero. In such times, if additional support is desired, the Fed can use other tools to influence financial conditions in support of its goals.

However, there are many factors that affect inflation and employment. And while the linkages from monetary policy to both inflation and employment are not direct or immediate, monetary policy is an important factor.

Definitions and Basics

Most economic arguments for government intervention are based on the idea that the marketplace cannot provide public goods or handle externalities. Public health and welfare programs, education, roads, research and development, national and domestic security, and a clean environment all have been labeled public goods.

Public Goods, from the Concise Encyclopedia of Economics

Public goods have two distinct aspects: nonexcludability and nonrivalrous consumption. “Nonexcludability” means that nonpayers cannot be excluded from the benefits of the good or service. If an entrepreneur stages a fireworks show, for example, people can watch the show from their windows or backyards. Because the entrepreneur cannot charge a fee for consumption, the fireworks show may go unproduced, even if demand for the show is strong….

Externalities, from the Concise Encyclopedia of Economics

Externalities are probably the argument for government intervention that economists most respect. Externalities are frequently used to justify the government’s ownership of industries with positive externalities and prohibition of products with negative externalities. Economically speaking, however, this is overkill.

Government Spending, from the Concise Encyclopedia of Economics

In the past, government spending increased during wars and then typically took some time to fall back to its previous level. Because the effects of World War I were not totally gone by 1929, the line for the United States from 1790 to 1929 has a very slight upward slant. But in the second quarter of the twentieth century, government spending began a rapid and steady increase. While economists and political scientists have offered many theories about what determines the level of government spending, there really is no known explanation for either part of this historical record….

Distribution of Income, from the Concise Encyclopedia of Economics

The distribution of income is central to one of the most enduring issues in political economics. On one extreme are those who argue that all incomes should be the same, or as nearly so as possible, and that a principal function of government should be to redistribute income from the haves to the have-nots. On the other extreme are those who argue that any income redistribution by government is bad….

Redistribution, from the Concise Encyclopedia of Economics

The federal government has increasingly assumed responsibility for reducing poverty in America. Its primary approach is to expand programs that transfer wealth, supposedly from the better off to the poor. In 1962, federal transfers to individuals (not counting payments for goods and services provided or interest for money loaned) amounted to 5.2 percent of gross domestic product, or 27 percent of federal spending (Stein and Foss 1995, p. 212). By 2000, federal transfers had increased to 10.9 percent of GDP, or approximately 60 percent of federal spending; GDP was $9.82 trillion and federal spending was $1.79 trillion. These transfers are commonly referred to as government redistribution programs, presumably from the wealthy to the poor. The unstated implication is that income was originally distributed by someone. But no one distributes income. Rather, incomes are determined in the marketplace by millions of people providing and purchasing services through voluntary exchanges, and government transfers necessarily limit these exchanges….
… Such an examination yields a striking fact: most government transfers are not from the rich to the poor. Instead, government takes from the relatively unorganized (e.g., consumers and general taxpayers) and gives to the relatively organized (groups politically organized around common interests, such as the elderly, sugar farmers, and steel producers).

Federal Budget, from the Concise Encyclopedia of Economics

Deficit spending has been a way of life for the federal government for most years since World War II. A whole generation of elected federal officials has come and gone without ever balancing the budget. The last time that federal budget expenditures were brought into balance with revenues was in 1969, and prior to that the last time was in 1960….

Taxation, from the Concise Encyclopedia of Economics

Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them….

In the News and Examples

Gina Miller Johnson, The Danger of Benevolent Paternalism: Socialization and the Role of Government. Econlib, July 2020.

If we assume public health is a desirable public good, then the question becomes, what is the proper scope of government in providing this good? The classical liberal might argue that at the local level, governments should take steps to provide or at least coordinate proper sanitation, waste disposal, and clean water—provisions that would either be unprofitable or unwieldy if left to the competitive market…
Whatever one’s view of the proper role of government as it relates to public health, another question must be posed: when, if ever, does public health provision as a public good supersede the protection of civil liberties as a fundamental role of the state?

Jon Murphy, Does National Security Justify Tariffs? Econlib, May 2018.

…even Adam Smith recognized a possible exception to free trade: using tariffs to support domestic industries that are vital to national defense. In the 21st century, are such tariffs for defense-relevant goods justified? My answer is: not likely.

Should government help people make better choices? Richard Thaler on Libertarian Paternalism. EconTalk podcast episode, November 2011.

Richard Thaler of the University of Chicago Graduate School of Business defends the idea of libertarian paternalism–how government might use the insights of behavioral economics to help citizens make better choices. Host Russ Roberts accepts the premise that individuals make imperfect choices but challenges Thaler on the likelihood that government, in practice, will improve matters. Along the way they discuss the design of Sweden’s social security system, organ donations and whether professors at Cornell University are more or less like you and me….

Can taxes correct externalities? Greg Mankiw on Gasoline Taxes, Keynes and Macroeconomics. EconTalk podcast episode, January 2007.

Greg Mankiw of Harvard University and Greg Mankiw’s Blog talks about the state of modern macroeconomics and Keynes vs. the Chicago School. He defends his proposal to raise gasoline taxes and discusses the politics of tax policy….

Social Security, from the Concise Encyclopedia of Economics

The Social Security system, including old-age and survivors insurance, disability insurance, and hospital insurance (Medicare), poses a staggering liability in the years ahead. Benefits in the year 2025, when the retirement of the baby-boom generation is in full swing, are projected to cost 23 percent of taxable payroll in the economy, up from 14 percent today….

A Little History: Primary Sources and References

An Animal That Trades: The Role of Authority, at AdamSmithWorks

Peace, easy taxes, and a tolerable administration of justice… These are the aims of Smith’s ideal government. Our society needs a state, and Smith offers meaningful guidance on how to evaluate its role.

What is a flat tax? What are the economic implications? Rabushka on the Flat Tax. EconTalk podcast episode, April 2007.

Alvin Rabushka of Stanford University’s Hoover Institution lays out the case for the flat tax, a reform of the current system that would replace the 66,000 page U.S. tax code with a single rate and no deductions other than personal exemptions. An individual tax return would fit on a simple postcard. Rabushka discusses the economic changes that would come with such a reform and the adoption of the flat tax around the world since Rabushka and Robert Hall proposed the idea in 1981….

Advanced Resources

Wealth of Nations Reading Guide, at AdamSmithWorks (Book V: Of the Revenue of the Sovereign of Commonwealth)

The AdamSmithWorks reading guides use three types of questions and highlighting to help guide readers.
The AdamSmithWorks reading guides use three types of questions and highlighting to help guide readers. The three types of questions are based on the Great Books Shared Inquiry Handbook, and are denoted by colour.

What role does the federal government play in the economy?

The government (1) provides the legal and social framework within which the economy operates, (2) maintains competition in the marketplace, (3) provides public goods and services, (4) redistributes income, (5) cor- rects for externalities, and (6) takes certain actions to stabilize the economy.

How can the federal government affect the national economy?

In the United States, the government influences economic activity through two approaches: monetary policy and fiscal policy. Through monetary policy, the government exerts its power to regulate the money supply and level of interest rates. Through fiscal policy, it uses its power to tax and to spend.

How can the federal government influence the economy quizlet?

The government mainly controls the economy by buying and selling stocks. It also controls taxes, trade affairs, and tariffs. They have to be constantly regulating these things to have price stability, economic growth, and low unemployment. For example, setting up a price level for specific items and goods.

How does the government use government spending to influence the economy?

The increased government spending may create a multiplier effect. If the government spending causes the unemployed to gain jobs then they will have more income to spend leading to a further increase in aggregate demand.