Stabilization Policies Chapter 16, Section 3

These are things that affect aggregate supply and demand. They either stimulate aggregate supply or aggregate demand.

Demand-Side Policies These specifically target aggregate demand. Fiscal policy – federal gov’ts attempt to stabilize the economy through taxing and gov’t spending.

Designed by John Maynard Keynes in 1936 Keynesian Economics Designed by John Maynard Keynes in 1936 Used until 1970’s

Helps set fiscal policies Set of actions designed to lower unemployment by stimulating aggregate demand.

Uses the GDP = C+I+G+(X-M) equation. Keynes blamed the Investment or Business sector for the instability in the economy.

Said that if investments were down, then workers lost job, which then sent the economy into a downward spiral. Called the multiplier effect – change in investment spending caused by a change in total spending.

Accelerator is the other part of Keynesian Economics that is caused by the Investment sector of GDP The change in investment spending caused by a change in total spending.

Government Role Keynes thought gov’t was the only thing big enough to fix the investment problem. Gov’t could slow down their spending to offset the decline in spending by businesses. Or, it could lower taxes.

These things will increase federal deficit, but Keynes thought it was a necessary evil in order to stop further declines in economic activity. After economy recovers, taxes can be raised again and debt can be paid back.

Automatic Stabilizers Programs that automatically trigger benefits if changes in the economy threaten income. Unemployment insurance Federal entitlement programs Progressive income tax

Unemployment Insurance Insurance that workers who lose their jobs through no fault of their own can collect for a limited amount of time. Can’t receive this if you have been fired because of misconduct or have quit without good reason.

Federal Entitlement Programs Welfare, gov’t pensions, medicare, medicaid, and Social Security. Help provide minimum health, nutritional, and income levels for selected people.

Progressive Income Tax Has tax brackets that you fit in according to your income. Can change if your income changes either for the better or worse.

Problems All of these programs are great, and the automatic stabilizers are the best, but the gov’t has a hard time bringing federal spending under control. This is why we are still in debt and cannot get out.

Supply-Side Policies Policies designed to stimulate output and lower unemployment by increasing production rather than demand. More popular because demand-side policies don’t seem to be working.

Both demand and supply-side policies have the same goal to increase production and decrease unemployment without increasing inflation.

Supply-side wants to reduce gov’t role in economy. Reduce number of federal agencies Deregulation – remove regulations that industries must follow Lower federal taxes on individuals and businesses

Lower Federal Taxes Believe if federal taxes are too high, then people won’t want to work and businesses will produce less. Lowered federal taxes allow individuals and businesses to keep more of the money they earn and will therefore work harder.

Lowering federal taxes has not worked and have since lost a lot of popularity.

Limitations Lack of experience with supply-side policies We don’t know how they will affect the economy.

Supply-side policies are designed more to promote economic growth rather than to remedy economic instability.

Monetary Policy Neither supply-side or demand-side policies are very concerned with money supply. Monetarism places primary importance on the role of money and its growth.

Monetarists think that changes in money supply have the greatest affect on unemployment and inflation.

Interest Rates and Inflation Believe inflation can be controlled if the money supply is allowed to grow at a slow but steady rate. IOW: increase money supply, but only a little bit at a time.

GDP will determine how fast and how much money supply will grow.

Unemployment Monetarists believe that increasing the money supply too much will have a negative effect on unemployment. IOW: increase money supply too much and it will worsen unemployment.