Economics: Today and Tomorrow © 2008

Chapter 17: Stabilizing the National Economy

Chapter Overviews

Section 1: Unemployment and Inflation
The federal government uses monetary and fiscal policies, or stabilization policies, to keep the economy healthy. The government uses methods and theories to avoid the two problems that destabilize the economy—unemployment and inflation. Unemployment can be classified as cyclical, structural, seasonal, or frictional. High unemployment is a sign that the economy is not well; on the contrary, low unemployment is a sign of a stable economy. Inflation is caused by excessive expansion of the money supply or government spending, according to the demand-pull theory.

Section 2: The Fiscal Policy Approach to Stabilization
The term fiscal policy refers to the federal government’s deliberate use of its taxation rates and expenditures to affect overall business activity. The Keynesian economists and the supply-side economists have two theories about how to obtain stabilization. Keynesian economists advocate the use of government spending to stimulate economic activity and reduce unemployment during recessions. A simple circular flow of income and output model is given. Supply-side economists advocate reductions in tax rates to stimulate private investment and employment.

Section 3: Monetarism and the Economy
Monetarism is the theory that deals with the relationship between the amount of money the Federal Reserve places in circulation and the level of activity in the national economy. Monetarists favor monetary policy rather than fiscal policy to stabilize the economy. Monetarists believe that the money supply should be increased at a steady rate of 3 to 5 percent per year for stable economic growth with low inflation. Monetarists believe that the main problem with fiscal policy is that it cannot be implemented effectively.