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Unit 26 — Stabilization Policy

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Purpose:

To discuss the arguments for and against active government counterstabilization policy.

Objectives:

  1. Classical and neo-classical economists believe that there is little the government can do to reduce unemployment and increase GDP/GNP growth, especially in the long run. They maintain that in the long run, fiscal stimulus raises interest rates and monetary stimulus raises prices without affecting real growth.
  2. Expectations may reduce the effectiveness of government stabilization policies.

    1. Expectations that the government will reverse an anti-inflation policy will keep the policy from being effective.
    2. "Rational expectations’ may keep a stimulative policy from lowering unemployment because individuals and firms may simply demand higher wages and prices.
  3. It is difficult to determine exactly what monetary policy to pursue because neither interest rates nor the money supply are perfect indicators of the restrictiveness of monetary policy.
  4. Government fiscal policy has often been complicated by political problems, and large structural deficits make it even more difficult to use discretionary fiscal policies.
  5. Financial mania and panics are “hardy perennials.” They progress in rather predictable phases and occur altogether too frequently, if you include the experience of other countries as well. While there is disagreement about whether or not they can be prevented, there is a consensus that, with good policies, they can be moderated and that the economic damage from them can be managed.

Audio and Transcripts

Meet the Series Experts

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Douglas Elliot

Douglas Elliot

Fellow at the Brookings Institution, specializing in the regulation of financial institutions and markets.

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Martin Feldstein

Martin Feldstein

Professor of Economics at Harvard University, President Emeritus of the National Bureau of Economic Research, and President Ronald Reagan’s Chairman of the Council of Economic Advisers.

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Karen Petrou

Karen Petrou

Co-founder and Managing Partner of Federal Financial Analytics, Inc., a privately held company that provides analytical and advisory services on legislative, regulatory, and public-policy issues affecting financial services companies doing business in the U.S. and abroad.

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Frederick H. Schultz

Frederick H. Schultz

Private Investor, owner of Schultz Investments, Vice Chairman of the Board of Governors of the Federal Reserve System, 1979–1982, and member of the Florida House of Representatives, 1963–1970.

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Beryl Sprinkle

Beryl Sprinkle

Chairman of the U.S. Council of Economic Advisers under President Ronald Reagan and author or co-author of many articles and books that discuss effects of monetary policy on financial markets and the economy.

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WHAT’S YOUR
ECONOMICS IQ?

  1. The Keynesian view of economics gained great popularity during the 1930s, MAINLY because:

    NNP was not tending toward full employment as the classicists had predicted.

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  2. During the late 1960s, the monetarists gained some ground over the Keynesians. This was probably due MAINLY to the fact that:

    the tax increase of 1968 was delayed in Congress and ultimately less effective than Keynesians had predicted.

    NEXT QUESTION
  3. Professor E. Z. Clarity, in discussing the causes of the Great Depression with her economics students, made this statement: “After all, you have to realize that investment declined by about 90% during this period. The result was an incredible decrease in aggregate demand—with nothing to make up for that loss in demand.” The perspective that Professor Clarity presents here MAINLY reflects the view endorsed by the:

    Keynesians.

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  4. Which of the following is probably the MOST PERSUASIVE argument in favor of a fixed-rate-of-growth rule to govern the money supply? The fixed-rate rule would:

    Eliminate the lag between monetary policy enactment and impact. There is no guarantee that the first option would occur, though some monetarists believe the fixed-rate rule would ease unemployment problems. The third option might be partly true, though the Fed would still be a powerful agency, and this is not an argument that has been used in favor of the fixed-rate rule. The fourth option is plainly false since economic slowdown, and not runaway growth, has been the problem of the past few years.

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  5. Which of the following statements would a rational expectationist MOST LIKELY agree with? The main cause of excess unemployment is:

    workers’ unwillingness to accept jobs at lower pay.

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  6. A supply-side economist would probably favor which of the following?

    Incentives to encourage more research and development among firms.

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Glossary

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