No Such Thing as a Free Lunch: Principles of Economics (Part 94)

When things go wrong on a macroeconomic level, it's almost always this way. People find someone to blame, whether it's blacks, whites, Christians, Jews, Muslims-whoever.

Jim Rogers

Introduction to Macroeconomics (Part C)

by

Charles Lamson

Government in the Macroeconomy

Much of our discussion of macroeconomics concerns the potential role of government in influencing the economy. There are three kinds of policy that the government has used to influence the macroeconomy:

1. Fiscal policy

2. Monetary policy

3. Growth or supply-side policies

 

Fiscal Policy

One way the federal government affects the economy is through its tax and expenditure (spending) decisions, or fiscal policy. The federal government collects taxes from households and firms and spends these funds on items ranging from missiles to parks to Social Security payments to interstate highways. Both the magnitude and composition of these taxes and expenditures have a major effect on the economy.

One of John Maynard Keynes's main ideas in the 1930s was that fiscal policy could and should be used to stabilize the level of output and employment. Specifically, Keynes believed the government should cut taxes and/or raise spending---called expansionary fiscal policies---to get the economy out of a slump. Conversely, he held that the government should raise taxes and/or cut spending---called contractionary fiscal policies---to bring the economy out of an inflation.

Monetary Policy

Taxes and spending are not the only variables the government controls. The Federal Reserve, the nation's central bank, determines the quantity of money in the economy. The effects and proper role of monetary policy are among the most hotly debated subjects in macroeconomics. Most economists agree that the quantity of money supplied affects the overall price level, interest rates and exchange rates, unemployment rate, and level of output. The main controversies arise concerning how monetary policy manifests itself and exactly how large its effects are.

Growth Policies

Many economists are skeptical about the government's ability to regulate the business cycle with any degree of precision using monetary and fiscal policy. Their view is that the focus of government policy should be to stimulate aggregate supply to stimulate the potential growth of aggregate output and income. A host of policies have been aimed at increasing the rate of growth. Many of these are targeted at specific markets and are largely discussed in microeconomics. One major worry of macroeconomists is that government borrowing to finance excesses of spending over tax collections (the "deficit") stop saving that would otherwise flow to businesses to be used for investment in capital. Another focus of pro-growth government policies has been the tax system. A major goal of tax reforms in 1981 and 1986 was to increase the incentive to work, save, and invest by lowering tax rates. In addition, the Taxpayer Relief Act of 1997 included a number of pro growth measures. And, furthermore, the Tax Cuts and Jobs Act of 2017 (TCJA) is a Congressional revenue act of the United States signed into law by President Donald Trump which amended the Internal Revenue Code of 1986. These types of policies are sometimes referred to as supply-side policies. 

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 380-381*

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