Archive for the 'Crowding-out Effect' Category

Jun 10 2008

Hunger, poverty and fiscal policy in the United States

Published by Michelle Close under

U.S. food stamp use up sharply, sign of hard times (Reuters) by Charles Abbott

27.88 million people in the US are going hungry this year. That’s 1.5 million more than last year. As food prices are rising all over the world, more low income families in the US are turning to the government for help.

In the US low incomes families and individuals can apply for food stamps. Food stamps are vouchers that can be used to purchase basic food items, milk, bread, eggs, cheese, chicken etc. These direct subsidies serve two functions, one is to feed more people and the other is to stimulate the domestic economy. With the unemployment rate at 5.5% and with inflation rising, everyone is affected but the poorest of the poor are most affected as they deal with these rising costs and shrinking incomes (less purchasing power).

“The record for food stamp participation is 29.85 million people in November 2005, which included emergency benefits to victims of hurricanes Katrina, Rita and Wilma, said USDA. Second-highest was 27.97 million people in March 1994, said the Food Research and Action Center, an antihunger group.”

In 2005 it was a major catastrophe that caused the jump in demand for food stamps. Today, the problem is much bigger, and broader. Rising fuel costs, rising costs of wheat, and the credit crunch are affecting businesses and businesses are beginning to lay off employees or are passing on their rising costs of production to the consumer, exacerbating rising inflation. So what can be done? Many people are encouraging Congress to take action.

“Now is the time for Congress to pass temporary increases in food stamps, extended unemployment insurance and other targeted relief that will stimulate the economy and help struggling families,” said James Weill, FRAC’s president. He pointed to May’s increase in unemployment, to 5.5 percent.

The Department of Food and Agriculture listed 1994 as the last time that 27 million people were using food stamps.

“Food stamp enrollment has exceeded 27 million people each month this fiscal year. USDA estimates enrollment will average 27.98 million people in fiscal 2009, which begins on October 1, at a cost of $40.3 billion.”

$40.3 billion dollars in government spending on food stamps alone seems like an enormous sum of money, but what is the alternative?

http://www.youtube.com/watch?v=BqmomJJ93Ps

Discussion Questions:

  1. What will be the affect of using expansionary fiscal policy at a time when inflation is already rising?
  2. How will increasing government spending on food stamps when the government is already running a budget deficit affect interest rates and private investment in the economy?
  3. What effect would expansionary fiscal policy have on aggregate supply if crowding-out of private investment occurs?
  4. How else could the government allocate the $40.3 billion it spends on food stamps to stimulate the economy and bring relief to the hungry poor? Brainstorm other policy options in your comments.

One response so far

Mar 12 2008

Helicopter Ben and Monetary Policy: the cartoon version!

Published by Jason Welker under

Monetary Policy

Much hoopla is made over the US Federal Reserve’s power to affect markets through its injections of liquidity into the economy. These days, the Fed appears to have some new tricks up its sleeve, but still uses its traditionally dominant tool of Open Market Operations to affect the Federal Funds rate, and thus the interest rates that commercial banks charge borrowers financing consumption and investment.

The power of monetary policy lies in the fact that spending stimulus can be achieved without running the risk of crowding-out, wherein expansionary fiscal policy drives up interest rates, potentially off-setting any increases in aggregate demand by triggering declines in consumption and investment due to increased borrowing costs.The whole aim of expansionary monetary policy, on the other hand, is to drive interest down by increasing the reserves held by commercial banks.

The cartoon above illustrates the process that leads to lower interest rates and greater spending when the Fed undertakes expansionary open market operations. Government bonds (the blue bills above) are held as assets by both commercial banks and the public. These are illiquid, meaning they cannot be spent. In order to stimulate new spending, the Fed can take some of its reserves of money (the green bills), and buy bonds from the public and banks.

Banks receive cash from the Fed, which increases their excess reserves. Further, the public will deposit the checks they receive from the Fed into their banks, increasing checkable deposits, which add to both the banks’ required reserves and excess reserves. The result is banks now have new liquidity that they want desperately to lend out in order to earn interest (remember, banks rarely want to hold onto their excess reserves, because inflation will erode the value of any money that’s not earning interest!).

When banks’ reserves increase, due to their growing checkable deposits and the inflow of cash from the Fed’s purchase of bonds, the supply of “federal funds” shifts down, lowering the interest rates that banks charge one another for overnight loans. These are loans that banks often give and receive in order to meet their reserve requirements at the end of a business day.

For example: If Bank A has finds at the end of the day that it has received more deposits than withdrawals, and it now has $1m more in its reserves than it is required to have, it wants to lend that money out as soon as possible to earn interest on it. Bank B, it just so happens, received more withdrawals than it did deposits during the day, and is $1m short of its required reserves at day’s end. Bank B can borrow Bank A’s excess reserves in order to meet its reserve requirement. Bank A will not lend it for free, however, and the rate it charges is called the “federal funds” rate, since banks’ reserves are held predominantly by their district’s Federal Reserve Bank.Federal Funds market

When the Fed buys bonds, all banks experience an increase in their reserves, meaning the supply of federal funds shifts out (or down in the graph above), lowering the “price” of federal funds, i.e. the federal funds rate. Lower interest rates on overnight loans will encourage banks to be more generous in their lending activity, allowing them to lower the prime interest rate (the rate they charge their most credit-worthy borrowers), which in turn should have a downward effect on all other interest rates.

Expansionary monetary policy involves the buying of government bonds on from the public and commercial banks by the Federal Reserve Bank. The result of this buying of bonds is an increase in the money supply, a decrease in real interest rates, and hopefully the stimulus of aggregate demand through new consumption and investment. Unlike expansionary fiscal policy (such as the stimulus package announced by Congress last month), crowding-out should not occur. Ideally, lowering the federal funds rate will lead to lower interest rates across the economy as a whole.

This, however, does not always transpire. In a future post, we’ll discuss why, and look at what the Fed is experimenting with today to stimulate investment and consumption, in response to the apparent failure of open market operations at providing the needed stimulus.

28 responses so far