Monetary Policies

Both demand-side economics and supply-side economics are concerned with stimulating production and employment. Neither policy assigns much importance to the money supply. A doctrine called monetarism, however, places primary importance on the role of money and its growth.

Monetarists believe that fluctuations in the money supply can be a destabilizing element that leads to unemployment and inflation. Because of this, they favor policies that lead to stable, long-term monetary growth at levels low enough to control inflation.

Interest Rates and Inflation in the short run, expansionist monetary policy can lower interest rates. This action would reduce the cost of consumer and business borrowing and shift the aggregate supply curve to the right. Real GDP would tend to increase, but so would the possibility of future inflation. The money supply can grow over time, but how fast should the money supply be allowed to grow?

Most monetarists believe that inflation can be controlled if the money supply is allowed to grow at a slow but steady rate. The rates of growth of real GDP and productivity would determine the

CHAPTER 16: ACHIEVING ECONOMIC STABILITY 453

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rate at which the money supply grows. For example, if the rate of growth of real GDP were 3 percent, and that of productivity 1 percent, the money supply would grow at about 4 percent without causing inflation. At this rate, there would be just enough extra money each year to buy the additional goods and services the economy produces.

This approach to inflation control is in sharp contrast to those tried earlier. In the early 1970s, for example, President Richard Nixon tried to stop inflation by imposing wage-price controls-regulations that make it illegal for businesses to give workers raises-or to raise prices without the explicit permission of the government. Most monetarists at the time said the controls would not work. The economy ultimately proved the economists correct: the controls did little to stop inflation.

Monetary Policy and Unemployment

Monetarists argue that attempts to cut unemployment by expanding the money supply provide only temporary relief. They argue that excessive rates of monetary growth eventually drive up prices and interest rates.

When rates eventually do go up, the cost of borrowing for businesses increases, which shifts the aggregate supply curve to the left. The larger money supply also shifts the aggregate demand curve to the right. The result is that real GDP would fall back to its original level-but at a different and much higher price level. The final result would appear as if the aggregate supply and demand curves shifted up together.

An overly expansionist monetary policy, then, will only cause long-term inflation. Monetary policy is not a long-term cure for unemployment.

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Deregulation and New Growth

The deregulation of the telecommunications industry and the breakup of AT&T have helped turn the telephone into an important component of the economy. The telephone is responsible for helping Sioux Falls, South Dakota, and Omaha, Nebraska, become major centers for the credit-card processing and telemarketing industries.

Checking for Understanding

1. Main Idea Compare the views of supply-side economists and demand-side economists regarding the role of government in the economy.

2. Key Terms Define fiscal policy, Keynesian economics, multiplier, accelerator, automatic stabilizer, unemployment insurance, supply-side economics, Laffer curve, monetarism, wage-price controls.

3. Describe the objectives of demand-side policies.

4. Identify the main assumptions of supply-side policies.

5. Explain how monetary policy could be destabilizing.

Applying Economic Concepts

6. Automatic Stabilizers Fiscal policy is one of the tools designed to stabilize the economy. First, define fiscal policy in your own words. Then, explain its role in shifting the aggregate demand curve.

7. Making Comparisons How do demand-side policies and supply-side policies differ from

8. Analyzing Information According to monetarists, how do fluctuations in the money supply affect the economy?

fx^L. Practice and assess key social studies skills with the Glencoe Skillbuilder Interactive Workbook, Level 2.

454 UNIT 4 MACROECONOMICS: POLICIES

454 UNIT 4 MACROECONOMICS: POLICIES

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