Economics: Today and Tomorrow © 2012

Chapter 17: Stabilizing the National Economy

Chapter Overviews

Section 1: Unemployment and Inflation
The government tries to balance unemployment and inflation in the economy. There are four types of unemployment: cyclical, structural, seasonal, and frictional. The unemployment rate measures the percentage of the civilian labor force that is without jobs but looking for work. In addition to unemployment, inflation is an economic problem that the government tries to stabilize. There are two theories of inflation: demand-pull and cost-push. According to the demand-pull theory, excessive demand "pulls" up prices. According to the cost-push theory, higher wages "push" up prices.

Section 2: The Fiscal Policy Approach to Stabilization
Most economists belong to one of two groups on the question of how best to stabilize the economy, balancing unemployment and inflation. One group believes that fiscal policy, which involves taxation and spending policies (as opposed to the monetary policy of the Fed), is the most important way to stabilize the economy. John Maynard Keynes, whose ideas became known as Keynesian theory, believed that the government should intervene in an economic recession to stimulate aggregate demand. Keynesian economists think that a central problem during a recession is reduced demand. In contrast, supply-side economists see supply, not demand, as the focus for economic stimulus. Supply-side economists think tax cuts stimulate private investment and employment.

Section 3: Monetarism and the Economy
Some economists believe that fiscal policy (which addresses taxation and spending) is not as important as monetary policy, which addresses how the Fed controls the rate of growth of the money supply. Supporters of monetary theory, called monetarists, believe that the Fed should increase the money supply at a smooth rate each year. Monetarists believe that the main problem with fiscal policy is that it cannot be implemented effectively.