Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Pricing

Average price of textbook across most common format

Up to 40-60% more affordable

Lifetime access on any device

$130

Hardcover print text only

$175

Hardcover print text only

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Content meets standard for Introduction to Anatomy & Physiology course, and is updated with the latest content

In-Book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

Explore this textbook

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Chapter 29: What We Have Learned and What We Have Not Yet Learned

Figure 29.1: Macroeconomics is important to our understanding of the everyday world that we live in. [1]

In this chapter, we summarize key macroeconomic ideas from throughout the semester. You will be asked to apply many of the concepts we have learned to the content of two newspaper articles, each almost 20 years old, and an almost 50-year-old presidential speech introducing a “New Economic Policy.” The goals of this course have included enhancing your abilities to read critically, understand news reporting, analyze economic events, and evaluate economic policy proposals. In the two newspaper articles and the presidential speech, think about the questions and write answers as preparation for a review of the material we have covered.

​29.1 Ideas for the Future

29.1.1​ Economic Growth

Growth in our capacity to produce (aggregate supply) determines changes in our standard of living over time. In the slowing growth of the 1970s, 1980s, and early 1990s, the major cause was slowing growth in productivity, not slowing growth in the amounts of capital and labor. The growth in the late 1990s, early 2000s, and since has been largely due to increases in technology.

29.1.2​ Inflation/Unemployment Tradeoff

In the short run, that is, periods of a few months to a year or two, there is a tradeoff between inflation and unemployment. In the short run, demand and supply shocks determine output, unemployment, and inflation. The tradeoff between unemployment and inflation does not exist in the long run.

29.1.3​ Unemployment

Cyclical unemployment is caused by fluctuations in aggregate demand and aggregate supply. The most common cause of fluctuations in unemployment seems to be changes in total spending. Monetary and fiscal policy can potentially reduce cyclical unemployment. However, because of lags between the identification of changes in economic conditions, decisions to take action, and the actual effects of policy, we have to forecast economic conditions in order to manage policy well. Although we are much better than we were even a few years ago, we are not perfect at that.

The full-employment or natural rate of unemployment is determined by the levels of frictional and structural unemployment. Those levels of unemployment fluctuate over time and cannot always be accurately predicted. As a result, we are often not sure whether the economy is above or below the full-employment level of real GDP. Frictional and structural unemployment can be reduced through training, education, and enhanced information systems for employees and employers.

29.1.4​ Inflation

In the short run, inflation can be caused by fluctuations in spending or in supply conditions. In the long run, growth in spending that is more rapid than the growth in full-employment output causes inflation – and money supply growth that is too high is the primary cause. Growth in the money supply in the long run does not affect the levels of unemployment or employment.

29.1.5​ Economic Policy

Changes in growth in the money supply will influence unemployment and inflation in the short run, but only change inflation in the long run. Fiscal policy effectiveness is severely limited by political constraints, but can have positive and negative consequences in the short run.

29.1.6​ The Twin Deficits

​Rising federal spending and revenues that were constant as a percentage of GDP were largely responsible for increasing federal budget deficits during the 1980s and early 1990s. (In the 1990s, a healthy economy, higher tax rates, and political pressure to reduce growth in spending and transfer payments were responsible for falling deficits.) After 2001, falling tax rates, a slowing economy, and rising spending created increasing budget deficits. Then, the most serious recession since the Great Depression added significant increases to the budget deficits. Increases in growth following the recession slowed the trend. The rising budget deficits after 2001 were paralleled by increases in our trade deficits. The mechanism connecting the two was the increasing value of the dollar.

29.2​ Important Questions Yet to Be Answered

29.2.1​ Economic Growth

How do we grow faster? We do not fully understand the cause of the slowing growth in productivity since the 1970s and the increase in the late 1990s. Therefore, we do not fully understand the solutions to slow growth and the causes of increased growth. We debate how to increase saving and investment and whether we should lower taxes, reduce regulation, and provide more and better education without evidence as to which is most effective.

29.2.2​ The Decline of the Full-Employment Rate of Unemployment

Why did the full-employment rate of unemployment decrease in the 1990s? How can we predict whether it will decrease or increase in the future? Answering these questions is crucial to effective use of monetary and fiscal policy.

29.2.3​ Costs of Moderate Inflation

We know that very high rates of inflation distort incomes and create inefficiencies within the economy. However, we do not fully understand the costs of more moderate inflation rates, beyond menu costs. The identification of the costs is particularly important given the short-run tradeoff between inflation and unemployment and the economic and political pressures to reduce unemployment.

29.2.4​ Costs of Federal Budget Deficits and Trade Deficits

There are many myths about federal budget deficits (and surpluses), but our real concerns are largely unanswered. We do recognize the potential costs of government deficits that are rapidly rising as a percentage of GDP. Deficits that are moderate and steady or falling as a percentage of GDP are much less serious. One of the results of an increasing government deficit can be an increasing trade deficit. The long-run costs of trade deficits are primarily that we may have to give up goods and services in the future.

29.2.5​ The Active Use of Monetary and Fiscal Policy

Given the significant lags of monetary and fiscal policies and our inability to do accurate forecasting, should we continually use monetary and fiscal policy to fine-tune the economy? We make errors and the incentives may reward short-run successes, to the detriment of long-run growth. Yet we have the potential to eliminate major, sustained increases in unemployment and inflation. We have few attractive policy options for effectively solving negative supply shocks. We know relatively little about curing deflation.

29.3 Case Studies

29.3.1 A Paradox 

In the 1990s and 2000s and for much of the time sense, headlines like “ The More the Japanese Save for a Rainy Day, The Gloomier It Gets” [1] appeared and the average annual growth rate for the last thirty years was three-tenths of one percent.  A famous economist argued that the Japanese should use the Helicopter Theory of monetary policy to stimulate the Japanese economy are striking in what they have in common. Once one of the fastest growing economies in the world, Japan was been stuck in a period of very little growth.  Only in the last few years does Japan appear to be recovering to a rate of growth above one percent.

Japan, the fourth largest economy in the world, prides itself on its ability to save.  At its peak, savings from corporations, government, and individuals reached almost a third of Japan’s GDP and twice that of the U.S. as a portion of GDP.

How can saving be so bad?   Don’t we learn at an early age to set aside a small amount for special occasions?  Bankers tell us to save more.  Financial advisers push us to save more.  Grandparents put money in piggy banks to their youngest grandchildren and say ‘learn to save’.  Financial literacy programs emphasize the importance of saving.  And even economists argue that more saving means more investment, higher productivity, and more economic growth and thus higher income for everyone.  Observers see that tax cuts to stimulate the Japanese economy are half as productive in stimulating spending in Japan as they are in the U.S.

Much of the saving has ended up in countries like the U.S., where saving has been at the opposite end of the spectrum.


Question 29.01

Question 29.01

Derive our equation relating saving and investment.

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Question 29.02

Question 29.02

Explain meaning of the equation and the mechanisms that lie behind it.

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Question 29.03

Question 29.03

Explain why increases in saving might be undesirable in the short run (the paradox of thrift), yet desirable in the long run.

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Question 29.04

Question 29.04

Many observers have suggested that the U.S. may be living off of Japanese saving. How can that be?

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Question 29.05

Question 29.05

What lessons can we learn from the Japanese experience?

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Question 29.06

Question 29.06

Will the current saving and investment patterns in the U.S. continue forever?

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Question 29.07

Question 29.07

Why is a reduction in the Federal deficit an increase in national saving? Why will investment cause higher productivity?

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Question 29.08

Question 29.08

Why are income tax cuts less effective in Japan than in the U.S.?

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Question 29.09

Question 29.09

Some Japanese even save more by putting money in safes rather than in banks when they are worried about financial stability and economic conditions. Does this make a difference in the effects on the money supply?

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Question 29.10

Question 29.10

Should the low interest rates in Japan be surprising? Why won’t consumers spend more?

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29.3.2 Broken Economic Principles?

​Ideas and Trends: Chaos Theory; ​Unlearning the Lessons of Econ 101

"There it goes again. Just when economists were wisely preparing a fat and happy America to face the inevitable unpleasant fallout from last summer's Asian financial crisis, the Government reported last week that things are going better than ever. Inflation is more or less gone. Jobs keep going up and growth continues." 

​​                   -Sylvia Nasar for the New York Times, May 3, 1998 [1]

​Read the rest of the above article here and answer the following questions: 

Question 29.11

Question 29.11

Low unemployment = high inflation. Is Sylvia Nasar correct? Has the principle broken down? What can we learn from the idea?

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Question 29.12

Question 29.12

Shrinking deficits = slower growth. Is this a true “turnaround in thinking”? Has the principle broken down?

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Question 29.13

Question 29.13

Rapid money growth = higher inflation. Is Sylvia Nasar correct? Has the principle broken down? What can we learn from the idea?

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Question 29.14

Question 29.14

World growth = higher oil prices. We need to think back to our initial discussions of supply and demand. Is Sylvia Nasar correct? Has the principle broken down? What can we learn from the idea?

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Question 29.15

Question 29.15

Stock prices = earnings expectations. This one is more difficult because we have not discussed the issues directly. If people begin to prefer stocks over alternative financial assets, for whatever reason, it will mean that for given earnings expectations, buyers will want to buy more stock. What will that do to stock prices? What will it do to the ratio of stock prices to earnings per share, a common way of evaluating stocks? What will it do to future rates of return on purchases of stocks?

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29.3.3: Presidential Address

The following speech was presented almost fifty years ago. It is important today not only because it contains more descriptions and proposals of a wider variety of economic policies than any other presidential speech, but it also has had a lasting effect on how our global economy works.

     Transcript of President Nixon's Address to the Nation – August 15, 1971

Good evening,

​I have addressed the nation a number of times over the past two years on the problems of ending a war. Because of the progress we have made toward achieving that goal, this Sunday evening is an appropriate time for us to turn our attention to the challenges of peace.

America today has the best opportunity in this century to achieve two of its greatest ideals: to bring about a full generation of peace, and to create a new prosperity without war.

This not only requires bold leadership ready to take bold action–it calls forth the greatness in a great people.

Prosperity without war requires action on three fronts: We must create more and better jobs; we must stop the rise in the cost of living; we must protect the dollar from the attacks of international money speculators.

We are going to take that action–not timidly, not half-heartedly, and not in piecemeal fashion. We are going to move forward to the new prosperity without war as befits a great people–all together, and along a broad front.

The time has come for a new economic policy for the United States. Its targets are unemployment, inflation, and international speculation. This is how we are going to attack them.

​[Unemployment]

​First, on the subject of jobs. We all know why we have an unemployment problem. Two million workers have been eased from the Armed Forces and defense plants because of the success in winding down the war in Vietnam. Putting those people back to work is one of the challenges of peace, and we have begun to make progress. Our unemployment rate today is below the average of the four peacetime years of the 1960s.

But we can and must do better than that.

The time has come for American industry, which has produced more jobs at higher real wages than any other industrial system in history, to embark on a bold program of new investment in production for peace.

To give that system a powerful new stimulus, I shall ask the Congress, when it reconvenes after its summer recess, to consider as its first priority the enactment of the Job Development Act of 1971.

I will propose to provide the strongest short-term incentive in our history to invest in new machinery and equipment that will create new jobs for Americans: A 10 percent Job Development Credit for one year, effective as of today, with at 5 percent credit after August 15, 1972. This tax credit for investment in new equipment will not only generate new jobs; it will raise productivity and it will make our goods more competitive in the years ahead.

​[Repeal of Automobile Tax]

​Second, I will propose to repeal the 7 percent excise tax on automobiles, effective today. This will mean a reduction in price of about $200 per car. I shall insist that the American auto industry pass this tax reduction on the nearly 8 million customers who are buying automobiles this year. Lower prices will mean that more people will be able to afford new cars, and every additional 100,000 cars sold means 25,000 new jobs.

​[Income Tax Exemption]

Third, I propose to speed up the personal income tax exemptions scheduled for January 1, 1973, to January 1, 1972–so that taxpayers can deduct an extra $50 for each exemption one year earlier than planned. This increase in consumer spending power will provide a strong boost to the economy in general and to employment in particular.

The tax reductions I am recommending, together with the broad upturn of the economy which has taken place in the first half of this year, will move us strongly forward toward a goal this nation has not reached since 1956, 15 years ago – prosperity with full employment in peacetime.

Looking to the future, I have directed the Secretary of the Treasury to recommend to the Congress in January new tax proposals for stimulating research and development of new industries and new technologies to help provide the 20 million new jobs that America needs for the young people who will be coming into the job market in the next decade.

[Reductions in Federal Spending]

​To offset the loss of revenue from these tax cuts which directly stimulate new jobs, I have ordered today a $4.7 billion cut in Federal spending.

Tax cuts to stimulate employment must be matched by spending cuts to restrain inflation. To check the rise in the cost of government, I have ordered a postponement of pay raises and a 5 percent cut in government personnel.

I have ordered a 10 percent cut in foreign economic aid.

In addition, since the Congress has already delayed action on two of the great initiatives of this Administration, I will ask Congress to amend my proposals to postpone the implementation of Revenue Sharing for three months and Welfare Reform for one year.

In this way, I am reordering our budget priorities to concentrate more on achieving full employment.

​[Cost of Living]

The second indispensable element of the new prosperity is to stop the rise in the cost of living.

One of the cruelest legacies of the artificial prosperity produced by war is inflation. Inflation robs every American. The 20 million who are retired and living on fixed incomes are particularly hard hit. Homemakers find it harder than ever to balance the family budget. And 80 million wage-earners have been on a treadmill. In the four war years between 1965 and 1969, your wage increases were completely eaten up by price increases. Your paychecks were higher, but you were no better off.

We have made progress against the rise in the cost of living. From the high point of 6 percent a year in 1969, the rise in consumer prices has been cut to 4 percent in the first half of 1971. But just as is the case in our fight against unemployment, we can and we must do better than that.

The time has come for decisive action–action that will break the vicious circle of spiraling prices and costs.

​[Wage-Price Freeze]

I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days. In addition, I call upon corporations to extend the wage-price freeze to all dividends.

I have today appointed a Cost of Living Council within the government. I have directed this council to work with leaders of labor and business to set up the proper mechanism for achieving continued price and wage stability after the 90-day freeze is over.

Let me emphasize two characteristics of this action: First, it is temporary. To put the strong, vigorous American economy into a permanent straitjacket would lock in unfairness; it would stifle the expansion of our free enterprise system. And second, while the wage-price freeze will be backed by government sanctions, if necessary, it will not be accompanied by the establishment of a huge price control bureaucracy. I am relying on the voluntary cooperation of all Americans–each one of you–workers, employers, consumers–to make this freeze work.

Working together, we will break the back of inflation, and we will do it without the mandatory wage and price controls that crush economic and personal freedom.

​[Freeing the Dollar]

The third indispensable element in building the new prosperity is closely related to creating new jobs and halting inflation. We must protect the position of the American dollar as a pillar of monetary stability around the world.

In the past seven years, there has been an average of one international monetary crisis every year. Who gains from these crises? Not the workingman; not the investors; and not the real producers of wealth. The gainers are international money speculators. Because they thrive on crises, they help to create them.

In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy– and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators.

​I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interest of the United States.

Now what is this action, which is very technical? What does it mean for you?

Let me lay to rest the bugaboo of what is called devaluation.

If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

The effect of this action, in other words, will be to stabilize the dollar.

Now this action will not win us any friends among the international money traders. But our primary concern is with the American workers, and with fair competition around the world.

To our friends abroad, including the many responsible members of the international banking community who are dedicated to stability and the flow of trade, I give this assurance: The United States has always been, and will continue to be, a forward-looking and trustworthy trading partner. In full cooperation with the International Monetary Fund and those who trade with us, we will press for the necessary reforms to set up an urgently needed new international monetary system. Stability and equal treatment is in everybody’s best interest. I am determined that the American dollar must never again be a hostage in the hands of the international speculators.

​[Import Tax]

​I am taking one further step to protect the dollar, to improve our balance of payments, and to increase sales for Americans. As a temporary measure, I am today imposing an additional tax of 10 percent on goods imported into the United States. This is a better solution for international trade than direct controls on the amount of imports.

This import tax is a temporary action. It isn’t directed against any other country. It is an action to make certain that American products will not be at a disadvantage because of unfair exchange rates. When the unfair treatment is ended, the import tax will end as well.

As a result of these actions, the product of American labor will be more competitive, and the unfair edge that some of our foreign competition has had will be removed. That is a major reason why our trade balance has eroded over the past fifteen years.

At the end of World War II the economies of the major industrial nations of Europe and Asia were shattered. To help them get on their feet and to protect their freedom, the United States has provided over the past 25 years $143 billion in foreign aid. This was the right thing for us to do.

Today, largely with our help, they have regained their vitality. They have become our strong competitors, and we welcome their success. But now that other nations are economically strong, the time has come for them to bear their fair share of the burden of defending freedom around the world. The time has come for exchange rates to be set straight and for the major nations to compete as equals. There is no longer any need for the United States to compete with one hand tied behind her back.

​[New Economic Policy]

The range of actions I have taken and proposed tonight–on the job front, on the inflation front, on the monetary front–is the most comprehensive New Economic Policy to be undertaken by this nation in four decades.

We are fortunate to live in a nation with an economic system capable of producing for its people the highest standard of living in the world; a system flexible enough to change its ways dramatically when circumstances call for change; and most important–a system resourceful enough to produce prosperity with freedom and opportunity unmatched in the history of nations.

The purposes of the government actions I have announced tonight are to lay the basis for renewed confidence, to make it possible for us to compete fairly with the rest of the world, to open the door to a new prosperity.

But government, with all its powers, does not hold the key to the success of a people. That key, my fellow Americans, is in your hands.

A nation, like a person, has to have a certain inner drive in order to succeed. In economic affairs, that inner drive is called the competitive spirit.

Every action I have taken tonight is designed to nurture and stimulate that competitive spirit; to help us snap out of that self-doubt and self-disparagement that saps our energy and erodes our confidence in ourselves.

Whether this nation stays number one in the world’s economy or resigns itself to second, third, or fourth place; whether we as a people have faith in ourselves, or lose that faith; whether we hold fast to the strength that makes peace and freedom possible in this world, or lose our grip–all that depends on you, on your competitive spirit, your sense of personal destiny, and your pride in your country and in yourself.

We can be certain of this: As a threat of war recedes, the challenge of peaceful competition in the world will greatly increase.

We welcome competition, because America is at her greatest when she is called on to compete.

As there always have been in our history, there will be voices urging us to shrink from that challenge of competition, to build a protective wall around ourselves, to crawl into a shell as the rest of the world moves ahead.

Two hundred years ago a man wrote in his diary these words: “Many thinking people believe America has seen its best days.” That was written in 1775, just before the American Revolution, at the dawn of the most exciting era in the history of man. Today we hear the echoes of those voices, preaching a gospel of gloom and defeat, saying the same thing: “We have seen our best days.”

I say, let Americans reply: “Our best days lie ahead.”

As we move into a generation of peace, as we blaze the trail toward the new prosperity, I say to every American: Let us raise our spirits. Let us raise our sights. Let all of us contribute all we can to the great and good country that has contributed so much to the progress of mankind.

Let us invest in our nation’s future; and let us revitalize that faith in ourselves that built a great nation in the past, and will shape the world of the future.

Thank you, and good evening.

-Text of President Richard M. Nixon’s August 15, 1971 Address to the Nation Outlining a New Economic Policy.


Question 29.16

Question 29.16

What were the problems identified by President Nixon?

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Question 29.17

Question 29.17

What were the causes of the increasing unemployment and inflation?

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Question 29.18

Question 29.18

What seemed to be President Nixon’s goals in planning his “New Economic Policy”?

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Question 29.19

Question 29.19

List the tax policies proposed. Identify whether they were intended to affect supply or demand.

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Question 29.20

Question 29.20

What effect should the government spending policies have had?

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Question 29.21

Question 29.21

What should have been the combined effect of the tax and spending policies?

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Question 29.22

Question 29.22

Why the wage-price freeze?

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Question 29.23

Question 29.23

What would have been the likely effects of his policy to “protect the position of the American dollar”?

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Question 29.24

Question 29.24

Why the import tax? Was it likely to be successful? Was it a “better solution for international trade than direct controls on the amount of imports”?

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Question 29.25

Question 29.25

What likely worked and what did not?

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Answer Keys:

Answer to Question 29.01

​GDP = C + I + G + NX

Income = C + S + T

GDP = Income

C + I + G + NX = C + S + T

I + G + NX = S + T

I = S + (T – G) – NX or

Investment = Private saving + Government saving – Net exports

Explanation:

Total spending is equal to total income. You can either consume part of your income, save part of it, or pay taxes. Subtracting consumption spending from both sides and then subtracting government spending and net exports from both sides gives us the equality that says investment spending is equal to saving (private saving (S) plus government saving (Taxes- G) plus goods sent from abroad (or minus goods sent abroad)).

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Answer to Question 29.02

If individuals save less (meaning they consume more), there are fewer resources left over for investment. If the government increases spending or lowers taxes, it must borrow and that means there are fewer resources left over for investment. If people from abroad send us more goods and services on balance, we can invest more given our levels of saving and public borrowing.

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Answer to Question 29.03

In the short run, an increase in saving may mean that consumers are spending less and saving more. Thus, overall spending in the economy decreases, and output and employment fall. However, in the long run, increased saving means there are more resources left over for investment, and economic growth will ultimately increase.

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Answer to Question 29.04

If that country spends more than it produces, it may be importing more than it exports. Other countries will be providing more goods and services than they are receiving in return. In essence, they are saving the dollar earned by doing so. Other countries that save more will be glad to make their savings available to the U.S. for a higher interest rate than they would get at home.

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Answer to Question 29.05

It appears that many Japanese save more regardless of the circumstances, plus they further increase their saving when concerned about overall economic conditions. Many Americans are not so conservative and careful with their budgets.

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Answer to Question 29.06

The U.S. is experiencing relatively large trade deficits, due primarily to insufficient saving given desired investment levels. That means one result is more borrowing from abroad. That increase in borrowing, if continued as an increasing portion of overall GDP, will eventually end as international investors decide to invest in alternative countries and withdraw their investments in the U.S.

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Answer to Question 29.07

A reduction in the federal deficit means that the federal government is borrowing a smaller portion of overall saving. Thus, that amount of saving left over and available for investment is now greater. Interest rates will decrease and investment spending is likely to increase as a result.

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Answer to Question 29.08

In the circumstances described, tax cuts in Japan ended up being saved. In the U.S., a large portion of a tax cut in normally spent, with a much smaller portion going into savings. 

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Answer to Question 29.09

It makes no difference from a macroeconomic sense. In either case, potential consumers were not spending part of their incomes. In the short run, that has a negative effect on overall spending. It does reduce the money supply, but that does not seem to be affecting spending in a significant way. 

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Answer to Question 29.10

We might expect consumers to save less given that the rewards to saving are so low. The opportunity cost of spending one’s savings is quite low if interest rates are so low. The opportunity cost of spending one’s savings is quite high if interest rates are high.

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Answer to Question 29.11

If spending rises and nothing else changes, there will be increased upward pressure on prices and downward pressure on unemployment. But since, in this case, unemployment is already relatively low, the increased pressure on prices will be greater than it otherwise would have been. This is the short-run trade-off. In the long run, an increase in spending will be followed by an increase in inflation and then a decrease in unemployment and then an eventual return to the original level of unemployment with more inflation.

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Answer to Question 29.12

An increase in taxes or a reduction in spending will reduce a government deficit. However, the changes in taxes and spending in the short run will reduce consumer and government spending and thus reduce GDP. So in the short run, the description works. In the long run, there will be more resources left over for private investment and thus potentially more growth. The statement is not relevant in the long run.

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Answer to Question 29.13

Total spending equals the velocity of money times the money supply. If velocity does not change and real output is at its maximum, an increase in the growth of money will cause prices to rise. The statement is accurate. If, however, the economy is not producing at the full employment level, the short-run effect of an increase in the money supply may eventually cause an increase in overall spending and output.

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Answer to Question 29.14

One would expect that economic growth would result in increases in the price of a relatively fixed resource, the price of which is determined in markets. The principle has not broken down. At the same time demand for energy increases, prices rise, and incentives to find new sources and develop energy saving technology increase. The long-run supply of oil is very likely more elastic than the short-run supply.

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Answer to Question 29.15

If buyers want to buy more stocks, stock prices will be bid up. That will mean that for a given amount of earnings, the ratio of stock prices to earnings will be rise. Future rates of return will therefore decrease.

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Answer to Question 29.16

Unemployment, inflation, downward pressures on the international value of the dollar, and rising imports.

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Answer to Question 29.17

Two million military and related workers reentering the domestic workforce was suggested as a major cause of the rise in unemployment – and indeed it was. It is less clear what the cause of the inflation was.

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Answer to Question 29.18

The obvious goals are reducing unemployment and inflation, with longer-term goals of rising productivity and sustained growth. He also appeared to have goals of reducing government spending and taxes. He wanted to reduce imports and to stabilize the international value of the dollar.

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Answer to Question 29.19

A tax credit on new machinery and equipment (demand and eventually supply); repeal of automobile tax (demand); lowering income taxes (demand); lower taxes for stimulating research and development (demand and ultimately supply), and finally raising taxes on imports by 10 percent (demand).

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Answer to Question 29.20

Proposed spending policies were to lower pay raises and numbers of people employed by the federal government, as well as a ten percent cut in foreign aid. Both reductions would have an effect on the size of the federal deficit. The first proposal would lower government spending in the U.S. economy, the opposite of a fiscal stimulus. This was designed to keep inflation in check with the additional expansionary policy actions.

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Answer to Question 29.21

The net effect appears to be a reduction in taxes and a smaller reduction in spending. The overall effect should have been a stimulative policy.

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Answer to Question 29.22

They would work, but may cause excess pressure on the price level, thus increasing the rate of inflation. If we expect the net effect to be a stimulative one and inflation is already a problem, then there might have been an even larger increase in inflation.

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Answer to Question 29.23

The President means to protect the value of the American dollar. If we were importing more than we were exporting, this would have increased the supply of dollars on the international market and thus lowered the international value of the dollar unless people abroad want to invest those dollars in the U.S.

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Answer to Question 29.24

The purpose was to reduce the trade deficit. Either a tariff on imported goods or quota on imports will reduce the amount of imports. However, the trade deficit depends more fundamentally upon the relative levels of spending and production in the domestic economy. An import tax will indeed reduce imports and eventually reduce exports.

The significant change in the international area was the “freeing of the dollar.” That was going from a fixed exchange rate to a freely fluctuating system.

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Answer to Question 29.25

A government cannot use tax cuts to stimulate employment while at the same time lowering spending to reduce inflationary pressures. The tax cuts would be stimulative and the spending cuts would be restrictive. In fact, equal amount of both are likely to have an overall smaller restrictive effect.

Wage-price freezes seldom work. As can be expected, shortages will be created and black markets may appear. In fact, this was the first of several attempts to hold price increases down.

The dollar was freed and the U.S. has been on a fluctuating exchange rate system since. In fact, it changed the way most of the world conducted international trade.

An import tax is likely to reduce imports. But with a floating exchange rate, the reduction in imports is likely to reduce the supply of dollars to the international market, causing the price of the dollar to rise. That, in turn, will cause exports to fall. The trade deficit will like return to the original amount.

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References 

[1] Jacob M. Schlesinger and David P. Hamilton, "The More the Japanese Save for a Rainy Day, the Gloomier It Gets," Wall Street Journal, July 21, 1998.


Image Citations

[1] Image courtesy of KangZeLiu under CC BY-SA 4.0.

Think back to the definitions of GDP, spending, and income, starting with GDP = C + I + G + NX.
Think about what happens if desired saving is greater or less than desired investment at current interest rates.
Think about the costs and benefits of saving to the overall economy.
What is the connection between higher interest rates in the U.S. and ‘other countries’ saving’?
What is different between Japanese consumers and consumers in the U.S.?
What were our current saving/investment patterns?
Think about what a government deficit does to the amount of saving available to invest.
Think about how tax cuts can be an effective fiscal policy.
Think about what saving is.
Think how we might expect consumers to behave if interest rates are below 1%.
Think about the trade-off between inflation and unemployment. Think about possible other changes.
Think about the effects of a deliberate reduction in the government deficit in the short run and then in the long run.
Think about the quantity theory of money.
Is everything else except for growth and the supply of oil remaining the same?
Use our thinking about basic supply and demand applied to financial markets.
There is a long list throughout the speech.
What would normally increase unemployment and inflation? What in this case did both?
Think of the obviously stated goals and consider what other goals he may have had in proposing these policies.
Think about the short-run effects and the long-run effects.
How does a fiscal policy stimulus work?
Think of each separately and then combine the effects.
Why would the fiscal policies not work by themselves?
Consider the value of the American dollar.
Think about the effects of an import tax on imports and on exports.
Think about each of the proposed steps in combination with the other steps. For example, think about a tax cut to stimulate employment combined with a spending cut to reduce inflation.