The Impact of Politics on Economic and Monetary Policy

by Jovan Johnson

Regardless or your level of interest, alignment, or ideals, policy shaped and reshaped by politicians at all levels of government impact the economy: your city, county, state, and country.

Voting

Elections can and usually do have a great impact on the economic and monetary policies of a city, state, and nation. Indeed, politicians usually make their economic plan a central part of their campaigns. There are various ways that politics influences both economic and monetary policy, including the setting of tax rates and creation of a government’s budget.

Taxes

Taxation has been and always will be a topic of heated political debate. The earliest known tax records date from approximately six thousand B.C.E. in the form of clay tablets discovered in the ancient city-state of Lagash in what is now Iraq. (http://www.worldtaxation.com/uncategorized/history-of-taxation.html). And for the next several thousand years, taxes would become more and more entrenched in the development of civilizations.

There are various types of taxes that permeate our daily lives, including sales, property, and income tax. Needless to say, almost everyone hates paying taxes, so a political candidate’s position on taxes can definitely influence voters. In fact, taxes were so disdained that the federal government didn’t even have the ability to tax income until passage of the 16th Amendment in 1913. (https://constitutioncenter.org/interactive-constitution/amendments/amendment-xvi)

The U.S. employs what’s known as a “progressive” tax system, which imposes a lower tax rate on low-income earners compared to higher income earners. (https://www.investopedia.com/terms/p/progressivetax.asp) The idea of course is that people who earn more income are in a better position to pay higher taxes, whereas low income earners need more of their income to survive.

However, some politicians subscribe to the so-called “trickle-down” theory of economics, which in a nutshell believes that giving tax breaks to the wealthy and corporations will stimulate growth of the economy and the subsequent benefits will “trickle-down” to the rest of society. Some economists characterize this approach as a purely political philosophy rather than one driven by science. (https://www.investopedia.com/terms/t/trickledowntheory.asp)

Taxation is one of the most powerful tools that a government has in its arsenal, especially since they can be used to influence social and political change. For example, after the Civil War, poll taxes were imposed by some southern states in an attempt to disenfranchise African American voters. (https://www.encyclopedia.com/social-sciences-and-law/political-science-and-government/political-science-terms-and-concepts/poll-tax). Because taxation can have such profound effects, candidates for office need to be clear about their tax policies so that voters can make an informed decision at the ballot box.

Monetary Policy

In the United States, the institution responsible for setting monetary policy is the Federal Reserve (a/k/a the “Fed”). Created in 1913, the Federal Reserve is the central bank for the U.S. which is charged with three primary goals: 1) stabilizing prices, 2) moderating interest rates, and 3) maximizing employment. (https://www.law.cornell.edu/uscode/text/12/225a) These are important topics that can have a real world impact on our daily lives. For example, a rise in interest rates will make money more expensive to borrow and may cause someone to re-think their home or car purchase. Also, if the Fed doesn’t effectively control inflation, which is the devaluing of the nation’s currency, then prices on everyday goods can skyrocket.

The Federal Reserve is a wide-reaching system that is governed by a seven-person board of governors who each serve staggered 14-year terms. Nominees are appointed by the President and confirmed by the Senate. (https://www.law.cornell.edu/uscode/text/12/241)

The Federal Reserve, however, is not subject to the control of the executive branch of government and was intentionally created to be independent in its actions and decision making. Therefore, nominations to the board of governors should ideally be apolitical. (http://www.igmchicago.org/surveys/fed-appointments) However, realistically, since the President and members of the Senate are inherently political figures, the party in office can seek to install nominees that share the same political views regarding monetary policy.

In addition to the board of governors, there are twelve regional Federal Reserve Banks, each with their own president, throughout the country that are charged with regulating privately owned commercial banks. The regional bank presidents are appointed nominated by a search committee and confirmed by the Fed’s board of governors.

Specifically, a committee within the Federal Reserve, the Federal Open Market Committee (FOMC), is in charge of setting monetary policy such as interest rates. (https://www.thebalance.com/how-does-the-fed-raise-or-lower-interest-rates-3306127) The FOMC is made up of all seven governors the twelve regional bank presidents, although due to governing structure, only five regional bank presidents can vote at any given time. The FOMC has three primary tools at its disposal:

1) Open market operations, which regulates the purchase and sale of securities on the open market by a central bank. (https://www.federalreserve.gov/monetarypolicy/openmarket.htm)

2) The discount rate, which is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Fed bank. (https://www.federalreserve.gov/monetarypolicy/discountrate.htm)

3) Reserve requirements, which is the amount of funds a bank is required to hold in reserve against specified deposit liabilities. (https://www.federalreserve.gov/monetarypolicy/reservereq.htm)

In order to avert an economic crisis, the Fed can utilize some or all of these tools to try and stabilize the economy and help restore consumer confidence.

Budgeting

A government budget is a document prepared by the government which presents its projected revenues and proposed spending for the upcoming financial year. In the U.S., the various executive departments (e.g. the Department of Defense, the Department of State) submit their budget proposals to the White House. Then, once those proposals are compiled and approved, the President presents his overall budget proposal to Congress.

In Congress, the various committees in the House and Senate work together to draft budget resolutions to set spending levels. Then, the Appropriations committees divide the discretionary section of the budget among its 12 subcommittees.

The resulting appropriations bills are voted on by the House and Senate. The bills go to conference committees if there are differences between them until a final version is agreed upon. Then, the President will sign the bills into law, thus setting the budget for the upcoming fiscal year. (https://www.usa.gov/budget)

Needless to say, politics can have a dramatic impact on how the government budget is set. Candidates running for office will usually have preferences regarding how the budget is formulated. For example, some candidates will favor more funding for the military, and others will favor increased spending on social programs.

It should be noted that these concepts are not completely separate from one another. For example, tax policy can greatly affect the government’s budget since a reduction in tax revenue can put a strain on the budget. In situations where taxes and other revenue aren’t enough to cover the spending costs in the budget, that gap is called the “deficit.” You’ve probably heard many politicians talk about the deficit and their ideas on how it can be reduced.

The deficit is paid for by selling Treasury securities like bonds, notes and bills. When a person buys these securities, the government pays back the principal plus interest. A large part of government spending is the interest owed on the deficit for all previous years. Together, all of the past years’ deficit combined is known as the “national debt.”

In order to pay its bills, the Treasury can borrow up to an amount called the “debt ceiling,” which Congress has the ability to raise. In the event that the debt reaches the ceiling, the government is unable to borrow more money and is therefore unable to pay its bills. As you’ve probably seen on the news, this can result in a “government shutdown” where certain government services are frozen and workers are furloughed. Some politicians will use shutdowns as a political tool in order to advocate their beliefs. However, these shutdowns have a real-world impact on people’s lives, including government workers who are sometimes forced to live without a paycheck. Accordingly, many politicians have found it unwise to engage in such extreme tactics.