Macroeconomic Growth And Stability

Since its origins, capitalism has been plagued by periodic bouts of inflation (rising prices) and recession (high unemployment). Since World War II, for example, there have been nine recessions in the United States, some putting millions of people out of work. These fluctuations are known as the business cycle.

Today, thanks to the intellectual contribution of John Maynard Keynes and his followers, we know how to control the worst excesses of the business cycle. By careful use of fiscal and monetary policies, governments can affect output, employment, and inflation. The fiscal policies of government involve the power to tax and the power to spend. Monetary policy involves determining the supply of money and interest rates; these affect investment in capital goods and other interest-rate-sensitive spending. Using these two fundamental tools of macroeconomic policy, governments can influence the level of total spending, the rate of growth and level of output, the levels of employment and unemployment, and the price level and rate of inflation in an economy.

Governments in advanced industrial countries have successfully applied the lessons of the Keynesian revolution over the last half-century. Spurred on by active monetary and fiscal policies, the market economies witnessed a period of unprecedented economic growth in the three decades after World War II.

In the 1980s, governments became more concerned with also designing macroeconomic policies to promote long-term objectives, such as economic growth and productivity. (Economic growth denotes the growth in a nation's total output, while productivity represents the output per unit input or the efficiency with which resources are used.) For example, tax rates were lowered in most industrial countries in order to improve incentives for saving and production. Many economists emphasized the importance of public saving through smaller budget deficits as a way to increase national saving and investment.

Macroeconomic policies for stabilization and economic growth include fiscal policies (of taxing and spending) along with monetary policies (which affect interest rates and credit conditions). Since the development of macroeconomics in the 1930s, governments have succeeded in curbing the worst excesses of inflation and unemployment.

Table 2-1 summarizes the economic role played by government today. It shows the important governmental functions of promoting efficiency, achiev

Failure of Market Economy

Government Intervention

Current Examples of Government Policy



Encourage competition

Antitrust laws, deregulation


Intervene in markets

Antipollution laws, antismoking ordinances

Public goods

Encourage beneficial activities

Build lighthouses, provide public education


Unacceptable inequalities of income and wealth

Macroeconomic problems:

Redistribute income

Progressive taxation of income and wealth Income-support or transfer programs (e.g., food stamps)

Business cycles (high inflation and unemployment)

Stabilize through macroeconomic policies

Monetary policies (e.g., changes in money supply and interest rates) Fiscal policies (e.g., taxes and spending programs)

Slow economic growth

Stimulate growth

Invest in education

Raise national savings rate by reducing budget deficit or increasing budget surplus.

TABLE 2-1. Government Can Remedy the Shortcomings of the Market

TABLE 2-1. Government Can Remedy the Shortcomings of the Market ing a fairer distribution of income, and pursuing the macroeconomic objectives of economic growth and stability. In all advanced industrial societies we find some variant of a mixed economy, in which the market determines output and prices in most individual sectors while government steers the overall economy with programs of taxation, spending, and monetary regulation.

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