Author: John Bouman

Financing Methods Most governments finance their budget deficits through 1. Borrowing funds from the public.  In the United States and other industrialized countries, this is the method through which governments finance the lion’s share of their deficit. Governments borrow funds from the public (households, businesses, and foreign investors) by issuing government bonds (long-term IOUs), notes (intermediate-term IOUs), and bills (short-term IOUs). These are nothing more than loans made by people or businesses to the government. You may have some government bonds of your own, and perhaps your pension fund or insurance company or financial institution has invested in government bonds. If so, you have loaned money to the government and are helping to finance the debt. This is not inflationary, because it constitutes a transfer of money from one economic group (households and businesses) to another (the government). However, it does decrease the availability of funds to the private sector. This is called “crowding out.” It leads to a decrease in private-sector spending and a decrease in private investments and economic growth. Crowding out usually raises interest rates beyond what they would be without government borrowing. Video Explanation For a video explanation of how governments borrow money, please visit: 2. Federal Reserve System financing. When securities (bonds, notes, and bills) are initially issued by the United States Treasury (in order to finance the federal government’s deficit), the public (households, businesses,...

Three Budget Philosophies Economists have varying opinions about how a government budget should be managed. The three most common budget philosophies are 1. The Annually Balanced Budget. A government annually balances its budget when, within one fiscal year, expenditures equal revenues. Most states, counties, and municipalities in the United States are required by law to balance their budgets. The United States federal government is not required to balance its budget. Attempts have been made to pass a constitutional amendment to balance the federal government’s budget. These attempts have failed primarily because of the Keynesian belief that the federal government needs to incur deficits in order to stimulate the economy during economic recessions. Classical economists believe that governments should balance their budgets each year. Some economists would even like to go beyond merely balancing our budget. They propose that governments should incur surpluses and set aside funds “for a rainy day” during healthy economic times. If the economy experiences a downturn, the surplus money should be used to finance essential government programs, without having to raise taxes and without causing the disadvantages of deficits mentioned at the bottom of this section. 2. The Cyclically Balanced Budget. A government cyclically balances its budget when, within the course of one business cycle, expenditures equal revenues. A business cycle consists of one expansion followed by a recession. Keynes proposed that the government should...

What’s in This Chapter? Is money, or the love of money, the root of all evil? Should we eliminate money? If we eliminate money, will all evil disappear? If we eliminate money, what economic consequences will this have? Are we better off with money than without money? What are the functions of money? These questions, among others, are answered in this unit. Nearly every country or region in the world has a central bank. The most important roles of a central bank are to supervise a nation’s banking system and to control its money supply. Sections 3 and 4 discuss the role of the central banks and the Federal Reserve (the Fed) System in the United States. The Federal Reserve is in charge of monetary policy in the United States. Its aim is to act independently from Congress and the White House. United States citizens do not elect Federal Reserve Board governors or central bank presidents. Governors are appointed by the President, and then approved by the Senate. The disadvantage is that the Fed governors are not directly accountable to the voters. The advantage is, however, that unlike politicians, Federal Reserve Board governors can act regardless of what may be the popular thing to do. They can, therefore, concentrate on long-run policies (they don’t often do this though). The Federal Open Market Committee (FOMC) is the day-to-day decision-making committee...

Is Money the Root of All Evil? Is money or the love of money the root of all evil? Some people claim this to be true. Would people still commit crimes in an economy without money though? The answer is “yes”. Some crimes involve no money (relationship abuse, control issues, power struggles, etc.). Or in the case of theft, people can steal things instead of money. Money makes it easier to commit certain crimes (it’s easier to rob a bank than to steal 1,000 chickens from a farm), but most people would agree that even without money, it’s human nature and not money itself that encourages some people to engage in evil acts. An Economy without Money Money has existed in many different forms throughout human history: salt, tobacco leaves, cigarettes, gold, and silver. Today it includes coins, paper bills, and electronic payments. Can an economy exist without money? In a barter economy, goods and services are directly traded for other goods and services, and no money is used. It is possible for such an economy to exist. However, trading is inconvenient and time-consuming, because buyers and sellers face double coincidences of wants. Let’s say that you are a sandal-maker and you would like to buy milk. In order to trade, you would need to find a person who not only sells milk, but also wants to buy sandals....

Money in Circulation In the United States, the Federal Reserve System and its twelve central banks are responsible for the circulation of money. In most other countries, a single central bank controls the amount of money in circulation. In Europe, the European System of Central Banks controls the money supply for the countries that belong to the European Union. In this unit, we will discuss the most common measures of our money supply, which include the Monetary Base, M-1, M-2, and M-3. Of these, M-1 and M-2 are by far the most frequently used. The Monetary Base The Monetary Base, or so-called high powered money, consists of primarily two things: currency in the hands of the non-bank public and bank reserves. Bank reserves include physical and electronically recorded cash balances held by banks. Currency consists of banknotes (paper money) issued through the Federal Reserve, and coins minted by the United States Mint (part of the United States Treasury). The monetary base is not the same as what economists refer to as the money supply. The monetary base includes funds held by banks. This money is not spent on the purchases of goods and services (if the money is not loaned out) and therefore does not affect economic activity. The money supply measures described in the next paragraphs do directly affect economic activity, because they include funds held by the...