By Jennifer Nicoll Victor, Ph.D., George Mason University
The US government uses fiscal policy and monetary policy to manage the economy. Depending on the economic problems being faced by the country, the government uses tools specific to these two economic policies. Also, the federal government runs a deficit when the federal government spends more in outlays than it takes in with revenue. Let us take a closer look at how the US government handles various challenges on the economic front.
The government debt is like all the deficits added together. Debt is divided into two categories: debt held by the public and intra-governmental holdings.
Debt held by the public is the sum of the year-to-year borrowing that government must do to cover all of its bills. In 2020, debt held by the public was around $17 trillion.
Intra-governmental holdings are money that one arm of government owes to another arm of the government. For example, if the Social Security program owes more in benefit payouts than it takes in with payroll tax receipts, it borrows from its own trust fund.
The trust fund builds up during years when receipts exceed benefit payouts. The trust fund is not literally a separate account where that money is held, just how the government tracks the receipts and spending through accounting. This method of tracking money accounts for the government having around $6 trillion in intra-governmental holding debt.
The total debt of the United States is therefore around $23 trillion.
The total gross domestic product of the United States is the sum total of all the goods and services bought and sold in a year. The current US GDP is around $21 trillion. This is where some economists raise concerns because, currently, the total US debt of $23 trillion is higher than the total GDP. So, by the measure used by some economists, the overall economic health of the US is up for debate.
This is a transcript from the video series Understanding the US Government. Watch it now, on Wondrium.
The government has tools for responding to two economic problems: unemployment and inflation.
High unemployment is a problem for economies because it means that many people who seek to find paid work cannot secure it and therefore cannot adequately participate in the economy.
Inflation is an opposite problem. When inflation is high, it means that consumer prices are rising faster than consumers can respond.
Fiscal Policy of the Federal Government
So, what can Congress and the president do to address these problems?
Congress and the president control fiscal policy. That means Congress and the president determine how much money government spends and how much it acquires in taxes.
When high unemployment is the problem, government can decrease taxes and increase government spending in an effort to stimulate the economy. Lower taxes are an economic stimulant because when consumers pay less money in taxes, it leaves them with more of their wages to spend on consumer goods, thereby energizing the overall economy. Government spending can also invigorate the economy because the more it spends on things like infrastructure or other government programs, the more money it injects into the overall economy, creating a stimulus.
On the other hand, if high inflation is a problem, the appropriate fiscal policy response is the opposite. When inflation is high, government seeks to increase taxes and decrease government spending. Tax increases slow the economy because it removes money from consumers’ wallets so they won’t spend so much on goods. Lowering government spending is also seen as a way to attempt to slow an economy that has rising prices.
Learn more about the danger of inflation.
Monetary Policy and Federal Reserve System
The monetary policy of the United States is controlled by the Board of Governors of the Federal Reserve System.
The Fed, as it is typically called, is made up of a chair and seven members, each from a different Federal Reserve District across the country, who are known as governors. All members of the Fed are appointed by the president and require Senate confirmation. They serve 14-year terms, both to encourage them to take a longer view of things and to provide them with some political independence. The primary responsibility of the Fed is to control the country’s money supply.
Responsibilities of the Fed
First, the Fed sets interest rates. Technically, the Fed sets the interest rate at which banks can borrow money from the Fed, as well as from one another. But all banks set consumer interest rates and these are based on the bank borrowing rates. So, when the bank rates go up because the Fed raises them, so do the consumer interest rates.
Second, the Fed also buys and sells treasury bonds. Treasury bonds are the primary tool that the government uses to finance its deficits. A treasury bond is like an IOU issued by the federal government. When the Fed sells treasury bonds it takes in money, thereby reducing the amount of money in the money supply. Selling bonds is a strategy for de-stimulating an economy. On the other hand, if the Fed wishes to stimulate the economy it can buy back bonds from investors who have purchased them in the past. By buying treasury bonds from the public, the Fed injects money into the money supply.
Learn more about the functioning of Congress.
Economic Tools used by the Fed
Thus, when the economic problem is that unemployment is high and government wishes to stimulate the economy, it buys bonds because when the government buys bonds back from investors, it is injecting cash into a sluggish economy.
However, when inflation is high, the Fed sells the bonds to take money out of the money supply.
The Fed also raises the interest rates to try to slow the economy when inflation is high. Conversely, it lowers the interest rates when unemployment is high in an attempt to encourage investors to borrow more money, so they can buy more things.
Common Questions about Economic Problems and the US Government Policies
Debt held by the public is the sum of the year-to-year borrowing that government must do to cover all of its bills. Intra-governmental holdings are money that one arm of government owes to another arm of the government.
High unemployment is a problem for an economy because it means that many people who seek to find paid work cannot secure it and therefore cannot adequately participate in the economy.
The Board of Governors of the Federal Reserve System have to serve 14-year terms to encourage them to take a longer view of things and to provide them with some political independence.