Question

1)What is the difference between the Discount Rate and the Federal Funds Rate?

2)What is the "crowding out effect"? What causes it?

3) What is meant by the term "automatic stabilizer"? What are some examples of automatic stabilizers? How do automatic stabilizers differ from discretionary fiscal policy?

Answer 1

1. Both the Fed Funds Rate and the Discount Rate are important monetary policy instruments that can be adjusted by the Fed to affect the money supply. The difference is that the discount rate is the interest rate a bank will have to pay when borrowing money from the Fed, while the Fed Funds rate is the rate that banks will have to pay when borrowing from each other. The Fed decides explicitly what the discount rate is based on the economy's current state. On the other hand, the Fed Funds Rate is determined by the demand and supply on the open market of loanable funds. The Fed sets a target for the Fed Funds rate and will then buy or sell Treasury bills to indirectly affect the rate until reaching that target rate. The discount rate was the primary tool used to expand or contract the money supply prior to open market operations (buying and selling Treasury bills to change the Fed Funds rate). The Fed now mainly uses the Fed Funds Rate, and many businesses are paying considerable attention to what the Fed announces as its target. Furthermore, adjusting the Fed Funds rate gives the Fed far more flexibility and power in its monetary policy than does the discount rate, because the Fed can control precisely how much to buy in T-bills

2. The effect of crowding out suggests that rising spending on the public sector is driving spending down the private sector.
The crowding-out effect is due to three main reasons: economics, social welfare, and infrastructure.
On the other hand, crowding in suggests that government borrowing can actually increase demand by creating jobs, thereby stimulating private spending. One of the most common forms of crowding out occurs when a large government, like the U.S. government, is increasing its borrowing. The sheer scale of this borrowing can cause the real interest rate to rise substantially, which has the effect of absorbing the lending capacity of the economy and discouraging businesses from making capital investments. Because companies often fund such projects in part or entirely through funding, they are now discouraged from doing so because the opportunity cost of borrowing money has risen, making it cost-prohibitive to traditionally profitable projects funded through loans.

3. Automatic stabilizers are a type of fiscal policy designed to compensate for fluctuations in the economic activity of a nation through its normal operation without additional, timely government or policymakers authorization. Progressively graduated corporate and personal income taxes are the best-known automatic stabilizers and transfer systems such as unemployment insurance and welfare. Automatic stabilizers are so-called as they act to stabilize economic cycles and are triggered automatically without further government action. Automatic stabilizers may include the use of a progressive tax structure under which the share of income received in taxes is higher when income is high and drops when income drops due to recession, job losses, or investment failure. As an individual taxpayer earns higher wages, for example, his additional income may be subject to higher tax rates on the basis of the current level structure When we look at economics, especially microeconomics, we look at budgets in modern governments around the world that use taxes and public welfare spending to help monitor inflation or deflation fluctuations. These stabilize financial cycles, corporate and personal income taxes are the best automatic stabilizers, as you can predict more accurately. When we look at discretionary budgetary instruments, instead of over the fiscal year, they are used to directly affect the economy at a single point in time. No fixed rules exist.