HGov: Economic Policy


Economic-Policy-logoThe economic role of the government stresses its promotion and regulation of economic interests and its fiscal and monetary policies that affect economic growth. Business benefits from government’s promotional efforts which take place largely in the context of group politics. Through regulation, government imposes restraints on business activity that are designed to promote economic efficiency and equity.  Through fiscal and monetary policies, the federal government attempts to maintain a strong and stable economy characterized by high productivity, high employment, and low inflation. Fiscal policy is based on government decisions in regard to spending and taxing. Monetary policy is based on the money supply and works through the Federal Reserve System.

The goal of economic theory is to advance the stabilization of the economy. Some of the major disputes over macro theory and policy is the disagreement on three questions. What causes instability? Is the economy self-correcting? Should government adhere to rules or use discretion in setting economic policy?

The classical theory of economics, which dominated in the 18th and early 19th centuries, laid the foundation for much of modern economics. Sometimes referred to as laissez faire economics, classical theory emphasized growth, free trade, and competition, as free from government regulation as possible. Classical theory argues for the self-regulating market. Under this viewpoint, the concern for profit ensures that society’s resources are used in the most beneficial manner, without direction by government.

Keynesian theory believes it is the government’s job to smooth out the bumps in business cycles. This theory asserts that free markets have no self-balancing mechanisms that lead to full employment. Therefore, intervention would come in the form of government spending and tax breaks in order to stimulate the economy and government spending cuts and tax hikes in good times, in order to curb inflation.

Monetarist theory focuses on the macroeconomic effects of the supply of money and central banking and contends that changes in the money supply are the most significant determinants of the rate of economic growth and the behavior of the business cycle.

The rational expectations theory holds that people generally correctly anticipate the economic effect of events and act on their expectations. According to this view, government policy actions that are correctly anticipated will often fail to achieve their intended effect. Rational expectations theory holds that attempts to stimulate the economy by increasing the rate of growth of the money supply will be ineffective as agents anticipate increased inflation. When monetary authorities loosen policy, firms raise prices and workers demand wage increases, which undermines the attempt to stimulate the economy.

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