Chris E. Carson's Blog

Addendum: Crash Course in Macroeconomics

Here's another one.

One other thing about politics in general: the only things Presidents have (marginal) control over is the tax rate and the chairman of the Fed, who controls the interest rate; it's called fiscal and monetary policy, respectively. To better understand what hand politics has in the economy, here's a crash course in macroeconomics:

It's been known since the 30s as a macroeconomic principle that lowering taxes stimulates the economy. The other way the government can do this is by increasing its expenditures. The idea is that the government will buy a nuclear missile, and the workers at the missile factory will take home extra profits and buy cars, and the workers at the car company will buy beer, etc., etc., etc. According to macroeconomics this kind of policy of increasing expenditures is supposed to be slightly more effective than lowering taxes because of a technicality where people save a little bit of their income, but now that US citizens spend almost 100% of their income on average this is becoming a moot point. These two methods of economic stimulus are where the economically-minded Democrats and Republicans are divided. Your policial belief on this policy depends on how effectively you think the government spends money (and how much of it ends up in senators' offshore accounts) and how equitably you think the stimulus should be distributed (should a check be sent to all citizens or to a bridge building company in Arkansas?)

Now, about monetary policy, it's basically at the core of what you would pay to finance a car or a mortgage. It has to do with how much the Federal Reserve charges to loan to banks and hold its' money; it's basically the banks' cost of holding money and doing business. That rate gets passed on to you with a couple points tacked on for the bank's profits. The general idea is that lower interest rates will encourage people to borrow and buy more things, build more factories, etc., while higher rates discourage this and encourage people to save money rather than spend it. It's often been argued that monetary policy is much more effective than fiscal because the government can much more easily control how investors use the money they already have than it has power to directly spend large chunks of money on the economy itself. Strength-in-numbers, essentially.
Again, the general mantra of macroeconomics is that large economic expansions usually cause inflation, at least when they run out of steam. The economy starts running out of resources, like workers, and the investors doing the expanding start offering higher prices and wages, causing prices overall to rise. If the Fed raises the inflation rate, investors stop demanding more resources and the demand for them starts to slacken, lowering prices.

The Fed's goal has always been to keep inflation low, which usually doesn't mean that we'll see any large economic growth if they have their way. With this new chairman that just got appointed, inflation will be very low if he does things right. It's not much of a political tool rather than an economic stabilization device, and the Fed's decisions have been attributed to a lot of expansions rather than the actions of the President.
Chris