Basic Instruction Unit 1



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Money, Taxes, Fiscal, Monetary Policy

• How does the government use taxes to fund programs?

• What are the Constitutional grounds for taxation?

• What is the impact of federal aid to state and local governments?

• How does the government use fiscal policy as a tool for achieving economic goals?

• How does fiscal policy impact the economy?

• What are the functions of the Federal Reserve System?

• What is monetary policy?

KEY TERMS TO REMEMBER

Contractionary Policies – fiscal policies, like lower spending and higher taxes that reduce economic growth

Deduction – variable amounts that you can subtract, or deduct, from your gross income

Entitlement – social welfare programs that people are “entitled to” if they meet certain eligibility requirements

Expansionary Policies – fiscal policies, like higher spending and tax cuts, that encourage economic growth

Federal Reserve System – the privately (Individuals) owned, publicly (government) controlled central bank of the United States.

• Board of Governors – the seven-member board that oversees the Federal Reserve System

• Districts – the twelve banking districts created by the Federal Reserve Act

FICA – taxes that fund Social Security and Medicare

Fiscal Policy – Congressional policies that use government spending and revenue collection to influence the economy

Fiscal Year – a 12-month period that can begin on any date

Interest Rate – the cost of borrowing money

• Discount Rate – the rate the FED charges for loans to member banks

• Federal Funds Rate – the rate member banks charge each other for loans

• Prime Rate – the rate banks charge on short-term loans to their best customers

Medicaid – entitlement program that benefits low-income families, some people with disabilities, and elderly people in nursing homes

Medicare – a national health insurance program that helps pay for health care for people over age 65 or with certain disabilities

Revenue – income received by a government from taxes and non-tax sources

Social Security – Old-Age, Survivors, and Disability Insurance (OASDI)

Tariff – a tax on imported goods

Tax – a required payment to a local, state, or national government

• Progressive Tax – a tax for which the percentage of income paid in taxes increases as income increases, i.e. – federal income taxes

• Proportional Tax – a tax for which the percentage of income paid in taxes remains the same for all income levels, i.e. – 6%, 10%, etc.

• Regressive Tax – a tax for which the percentage of income paid in taxes decreases as income increases, i.e. – sales taxes

Taxable Income – income on which tax must be paid; total income minus exemptions and deductions

Treasury –

• Bill – a government bond that is repaid within three month to a year

• Bond – a government bond that can be issued for as long as 30 years

• Note – a government bond that is repaid within two to ten years

Withholding – taking tax payments out of an employees’ pay before he or she receives it

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Money and its Uses

Uses

1.

2.

3.

Characteristics

1.

2.

3.

4.

5.

6.

Types

• ____________________– objects that have value in and of themselves and that are also used as money, i.e. salt, cattle, precious stones

• ____________________– objects that have value because the holder can exchange them for something else of value, i.e. receipts that could be exchanged for silver or gold

• ___________________ – valuable because the government says it is “__________”

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Fiscal Policy

How does each of these affect the economy?

Expansionary

Increase government spending

Cut Taxes

Contractionary

Decrease government spending

Increase Taxes

Taxes

Characteristics of a Good Tax:

1. Simplicity – tax laws should be simple and easily understood. Taxpayers should be able to keep the necessary records, prepare their own ax forms, and pay the taxes on a predictable schedule.

2. Efficiency – Government administrators should be able to collect taxes without spending too much time or money. Similarly, taxpayers should be able to pay axes without giving up too much time. They should also not have to pay too much money in fees.

3. Certainty – It should be clear to the taxpayer when a tax is due, how much money is due, and how the tax should be paid.

4. Equity – The tax system should be fair, so that no one bears too much or too little of the tax burden.

History of banking

• 1791 – Congress set up a 20 year charter and created the Bank of the United States

• 1811 – Charter expires and chaos breaks out b/c there is no consistency

• 1816 – Congress charters the Second Bank of the United States – 20 year charter also

• 1832 – President Jackson vetoed the renewal of the bank

• 1827 thru 1863 – The Free Banking Era – basically, chaos again

• 1860’s – Currencies in both the north and the south

• 1863/1864 – National Banking Acts resorted confidence in paper money

• 1870’s – Nation adopted the Gold Standard – a monetary system in which paper money and coins are equal to the value of a certain amount of gold (See Wizard of Oz)

• 1914 – The Federal Reserve System was established – the nation’s first true central bank

• 1933 – Federal Deposit Insurance Corporation (FDIC) is established to insure customer deposits if a bank fails - $250K per account

Structure of the Federal Reserve System

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(Source: Economics in Action. Prentice Hall: Boston)

Federal Reserve Districts

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Functions of the Federal Reserve System

1. Serves as the bank of the US Government

2. Serves as the agent for the Treasure Department to sell, transfer, and redeem government bonds, bill, and notes, or securities.

3. Issues paper currency and removes worn, torn, or old bills from circulation

4. Serves member banks

a. Check clearing

b. Supervises lending practices

c. Lender of last resort

i. Banks generally lend to each other, not the FED

Measuring the money supply

• M1 – currency, checking accounts, traveler’s checks

• M2 – Savings deposits, money market funds, CD’s

Monetary Policy

• Federal Open Market Committee (FOMC) – makes key decisions about interest rates and the money supply

o Higher interest rates reduces the amount of money in circulation – money is “too expensive” to borrow. The FED will raise the discount rate (tight)

o Lower interest rates increases the amount of money in circulation – money is “cheap” to borrow – The FED will lower the discount rate (easy/loose)

• Reserves – fractional reserve system [Reserve Requirement Ratio (RRR)]– banks hold a percentage of each deposit in reserve – generally 5% – 20%. Currently, the reserve rate is 10%. This rate is not changed often because of the huge impact on the money supply

The lower the RRR, the looser the policy.

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• Money Creation – this does not mean the treasury prints money. The banks simply go about doing business as usual.

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In your groups, complete the information below:

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• Open Market Operations – the buying and selling of government securities (bonds)

o Purchases – increases the money supply by giving the banks more money to loan out (easy/loose)

o Sales – decreases the money supply by taking money from the banks leaving them less money to loan out (tight)

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KEY POINTS TO REMEMBER

1. The functions and characteristics of money

2. Taxes provide the government with a source of income with which to fund government programs

3. There are six major source of revenue: individual income taxes, corporate income taxes, excise taxes, estate taxes, gift taxes, tariffs.

4. Fiscal policy is used by the Congress to stabilize the economy

5. The FED was created to stabilize the nation’s banking system.

6. The FED uses monetary policy to lessen the effects of business cycles

Questions to Master

1. How does a $1 bill display all six characteristics of money?_____________________________

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2. What is the difference between a progressive tax and a regressive tax?___________________

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3. What is the purpose of FICA? ___________________________________________________

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4. What is an entitlement program? Give three examples and explain their purpose _____________________________________________________________________________

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5. What is the difference between easy/loose money policies and tight money policies?

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NOTES:

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