Laissez-faire Versus Government Intervention
Historically, the US government policy toward business was summed up by the French term laissez-faire – ‘leave it alone’. The concept came from the economic theories of Adam Smith, the 18th-century Scot whose writings greatly influenced the growth of American capitalism. Smith believed that private interests should have a free rein. As long as markets were free and competitive, he said, the actions of private individuals, motivated by self-interest, would work together for the greater good of society. Smith did favor some forms of government intervention, mainly to establish the ground rules for free enterprise. But it was his advocacy of laissez-faire practices that earned him favor in America, a country built on faith in the individual and distrust of authority.
Laissez-faire practices have not prevented private interests from turning to the Government for help on numerous occasions, however. Railroad companies accepted grants of land and public subsidies in the 19th century. Industries facing strong competition from abroad have long appealed for protections through trade policy. American agriculture, almost totally in private hands, has benefited from government assistance. Many other industries also have sought and received aid ranging from tax breaks to outright subsidies from the Government.
Government regulation of private industry can be divided into two categories – economic regulation and social regulation. Economic regulation seeks, primarily, to control prices. Designed in theory to protect consumers and certain companies (usually small businesses) from more powerful companies, it often is justified on the grounds that fully competitive market conditions do not exist and therefore cannot provide such protections themselves. In many cases, however, economic regulations were developed to protect companies from what they described as destructive competition with each other. Social regulation, on the other hand, promotes objectives that are not economic – such as safer workplaces or a cleaner environment. Social regulations seek to discourage or prohibit harmful corporate behavior or to encourage behavior deemed socially desirable. The government controls smokestack emissions from factories, for instance, and it provides tax breaks to companies that offer their employees health and retirement benefits that meet certain standards.
American history has seen the pendulum swing repeatedly between laissez-faire principles and demands for government regulation of both types. For the last 25 years, liberals and conservatives alike have sought to reduce or eliminate some categories of economic regulation, agreeing that the regulations wrongly protected companies from competition at the expense of consumers. Political leaders have had much sharper differences over social regulation, however. Liberals have been much more likely to favor government intervention that promotes a variety of non-economic objectives, while conservatives have been more likely to see it as an intrusion that makes businesses less competitive and less efficient.
About the USA, Outline of the US Economy
Money in the US Economy
While the budget remained enormously important, the job of managing the overall economy shifted substantially from fiscal policy to monetary policy during the later years of the 20th century. Monetary policy is the province of the Federal Reserve System, an independent US government agency. ‘The Fed’, as it is commonly known, includes 12 regional Federal Reserve Banks and 25 Federal Reserve Bank branches. All nationally chartered commercial banks are required by law to be members of the Federal Reserve System; membership is optional for state-chartered banks. In general, a bank that is a member of the Federal Reserve System uses the Reserve Bank in its region in the same way that a person uses a bank in his or her community.
The Federal Reserve Board of Governors administers the Federal Reserve System. It has seven members, who are appointed by the President to serve overlapping 14-year terms. Its most important monetary policy decisions are made by the Federal Open Market Committee (FOMC), which consists of the seven governors, the President of the Federal Reserve Bank of New York, and Presidents of four other Federal Reserve banks who serve on a rotating basis. Although the Federal Reserve System periodically must report on its actions to Congress, the governors are, by law, independent from Congress and the President. Reinforcing this independence, the Fed conducts its most important policy discussions in private and often discloses them only after a period of time has passed. It also raises all of its own operating expenses from investment income and fees for its own services.
The Federal Reserve has three main tools for maintaining control over the supply of money and credit in the economy. The most important is known as open market operations, or the buying and selling of government securities. To increase the supply of money, the Federal Reserve buys government securities from banks, other businesses, or individuals, paying for them with a check (a new source of money that it prints); when the Fed’s checks are deposited in banks, they create new reserves – a portion of which banks can lend or invest, thereby increasing the amount of money in circulation. On the other hand, if the Fed wishes to reduce the money supply, it sells government securities to banks, collecting reserves from them. Because they have lower reserves, banks must reduce their lending, and the money supply drops accordingly.
The Fed also can control the money supply by specifying what reserves deposit-taking institutions must set aside either as currency in their vaults or as deposits at their regional Reserve Banks. Raising reserve requirements forces banks to withhold a larger portion of their funds, thereby reducing the money supply, while lowering requirements works the opposite way to increase the money supply. Banks often lend each other money over night to meet their reserve requirements. The rate on such loans, known as the ‘federal funds rate’, is a key gauge of how ‘tight’ or ‘loose’ monetary policy is at a given moment.
The Fed’s third tool is the discount rate, or the interest rate that commercial banks pay to borrow funds from Reserve Banks. By raising or lowering the discount rate, the Fed can promote or discourage borrowing and thus alter the amount of revenue available to banks for making loans.
These tools allow the Federal Reserve to expand or contract the amount of money and credit in the US economy. If the money supply rises, credit is said to be loose. In this situation, interest rates tend to drop, business spending and consumer spending tend to rise, and employment increases; if the economy already is operating near its full capacity, too much money can lead to inflation, or a decline in the value of the dollar. When the money supply contracts, on the other hand, credit is tight. In this situation, interest rates tend to rise, spending levels off or declines, and inflation abates; if the economy is operating below its capacity, tight money can lead to rising unemployment.
Many factors complicate the ability of the Federal Reserve to use monetary policy to promote specific goals, however. For one thing, money takes many different forms, and it often is unclear which one to target. In its most basic form, money consists of coins and paper currency. Coins come in various denominations based on the value of a dollar: the penny, which is worth one cent or one-hundredth of a dollar; the nickel, five cents; the dime, 10 cents; the quarter, 25 cents; the half dollar, 50 cents; and the dollar coin. Paper money comes in denominations of $1, $2, $5, $10, $20, $50, and $100.
A more important component of the money supply consists of checking deposits, or bookkeeping entries held in banks and other financial institutions. Individuals can make payments by writing checks, which essentially instruct their banks to pay given sums to the checks’ recipients. Time deposits are similar to checking deposits except the owner agrees to leave the sum on deposit for a specified period; while depositors generally can withdraw the funds earlier than the maturity date, they generally must pay a penalty and forfeit some interest to do so. Money also includes money market funds, which are shares in pools of short-term securities, as well as a variety of other assets that can be converted easily into currency on short notice.
The amount of money held in different forms can change from time to time, depending on preferences and other factors that may or may not have any importance to the overall economy. Further complicating the Fed’s task, changes in the money supply affect the economy only after a lag of uncertain duration.
About the USA, Outline of the US Economy