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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Introducing Economic Concepts

Introducing Concepts - Monetary Policy and Fiscal Policy


Monetary Policy and Fiscal Policy

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Alright, let's introduce two more important topics here. The ideas of monetary policy and fiscal policy. So, we start this discussion, we think about a self regulating economy, and this was first introduced by Adam smith in the wealth of nations, this idea of the free market and the invisible Hand that would guide the free market and that would fix all the problems. So problems such as unemployment, they would be resolved without intervention. Just let the free market go its course, anything bad in the economy, it's gonna figure itself out. Well, this theory was kind of shattered this idea of the Invisible Hand. It was shattered in the 1930s, where they were kind of saying, Hey, let it work itself, let it work itself out, and the Great Depression just got worse and worse. And even any intervention that they tried to make was not helping either, because they had not any good ideas of what to do. Okay, so what we've what we're going to study here in this course and what generally you study in a first introductory course, we're gonna focus on this Keynesian economics. Keynes, because it was developed by this guy, john Maynard Keynes, john Maynard Keynes developed keynesian economics and that's generally what we're going to focus on here. So what did the, what did he say in his economics? His idea was that these economic slums. He worked, he studied the Depression, he studied these problems and he said that these economic slumps are caused by inadequate spending, inadequate spending, meaning there's not enough GDP, not enough production happening, not enough going on in the economy. And if the economy itself will not have this spending happening without intervention? Well, we are going to intervene. The government can intervene and help with the spending to help mitigate the problems that are happening in the economy. Okay. So there, the way the government can participate is twofold, there can be the monetary policy and the fiscal policy. So let's first discuss monetary policy and monetary policies. This is changing the quantity of monitor quantity of money. And we're gonna go into more detail, we're gonna show all sorts of graphs, the demand and supply of money and future videos. And we're basically gonna see that the quantity of money is gonna affect interest rates and also affect overall spending. Um and when we talk about monetary policy in the US, the monetary policy is administered by the Federal Reserve. We have a private institution, the Federal Reserve that works with the government to uh to handle the monetary policy. They're the ones who handle the quantity of money available. Okay, so monetary policy is handled by the Federal Reserve, compare that with fiscal policy. So this is changes in government spending and taxes. And we say that any changes in the government spending or changes in taxes, those are also gonna affect overall spending. So remember that Keynes, john Maynard Keynes theory is that these inadequate spending is what's causing problems in the economy. So how we fix that well by affecting overall spending through monetary policy and affecting overall spending through fiscal policy here as well. Okay, So who who administers our fiscal policy? This is in general, federal government, other governments do it as well. We've got state and local governments that also get involved in their own fiscal policy. But in general, we're talking about as a nation, the federal government, the US federal government is going to administer the fiscal policy. So we talked about two things government spending and taxes. So how is the government, how does the government really affect the overall spending through this? Uh So the first one, the government spending, what can they do? They can create jobs, right. They can say like like back during the Great Depression, let's create this highway system, right? Let's create a highway system throughout the USa and that created a lot of jobs, right? There were a lot of jobs um to you know, spent to build this highway system, Right? So they can create jobs uh to reduce the unemployment that employs more people that helps us get out of the recession. Or they can protect they can take a preventative measure and they can prevent people from having these economic hardships through welfare programs, right? Help when you're unemployed, you get unemployment checks, welfare checks for poor people, public institutions like education, things like that, Right? Uh So government spending can help in those situations and changing tax policy, right? If they change tax policy, it's gonna affect the amount of money available. So an increase in taxes, right? Might see an increase in revenue for the government or a decrease in taxes, an increase in revenue for the public. So depending on the tax policy that gets put in place, it's going to affect the level of spending the level of income that's available um for these different institutions. Cool. So what we're gonna see on this graph is very interesting. It's comparing um industrial output. So generally a measure of production. This is kind of a measure of sort of like GDP So we can think of it like GDP. So like a level of production. And remember when we when we were talking about these economic slumps, it was a decrease in spending a decrease in production in the economy. So what we have is the two different depressions that we've had recently. We had the Great Depression in the 1930s, through 1930s. And then we have the recent recession. So what we have here this dark purple line, that's the Great Depression and then we have an analysis of what we call the great recession that happened In 2008, 2009. So like I said at the beginning of this video during the Great Depression, they kind of said, hey let the free market work its way out. It's gonna figure it out and notice what happened the G. D. P. This this measure of G. D. P. World industrial output kept falling for months, months since the peak and output. So that recession remember after a peak we're going through a recession and look how long it took for the recovery to start almost more than three years. Right? That that it was decreasing and decreasing kind of stagnant. So there was a long time that there was nothing happening there. However in 2009 there was a lot more studies of economics have been done and we were following these ideas of monetary and fiscal policy. There was changes in government spending bailouts of the banks, things like that and notice how much quicker we recovered. So there was this small recession lowering of the output here but then a recovery started to happen much more swiftly during the great recession because of the government intervention that happened. So this graph kind of shows that the government intervention does help and can help us swing out of these recessions a little more smoothly than just letting the free market run its course. Okay so we're gonna go into a lot more detail of how monetary policy and fiscal policy is carried out in future videos. But that's later in the course for now just keep big picture idea of what's going on here and let's go ahead and move on to the next video