Economic Stabilisation: Fiscal Policy

INTRODUCTION: MACROECONOMIC POLICY AND STABILISATION

• The economy often experiences fluctuations in economic activity, leading to periods of recession or inflation. During recession, national income, output and employment fall below potential levels, resulting in idle capacity, unused capital stock and rising unemployment.

• At other times, the economy becomes overheated, leading to inflation, characterized by persistent rise in prices and excess demand.

• Classical economists believed in an automatic self-correcting mechanism through flexible wages and prices, which would restore full employment and control inflation without government intervention.

• However, the severe Great Depression of the 1930s and post-World War II experiences demonstrated that automatic adjustment mechanisms often fail to restore economic stability.

• Keynes argued that active government intervention is necessary to stabilize the economy and combat recession and inflation through appropriate macroeconomic policies.

• The two main instruments of macroeconomic policy are fiscal policy and monetary policy. Keynes emphasized fiscal policy as the more effective tool for overcoming depression, considering monetary policy relatively ineffective in such situations.

• Modern economists generally recognize that both fiscal and monetary policies play important roles in stabilizing the economy.

GOALS OF MACROECONOMIC POLICY

• Stabilising the economy at a higher level of employment and national output is not the only goal of macroeconomic policy. Ensuring price stability is its another goal. Both inflation, (that is, rising prices) and deflation (that is, falling prices) have bad economic consequences.
• It is therefore desirable to achieve price stability. Similarly, every nation wants to raise the level of living of its people which can be attained through bringing about economic growth which in turn depends on raising the rates of saving and investment and accumulating capital.
• Macro-economic policies can play a useful role in raising the rate of saving and investment and therefore ensure rapid economic growth. Thus, three important goals or objectives of macroeconomic policy (both fiscal and monetary) are follows:
  
  1. Economic stability at a high level of output and employment.
  2. Price stability.
  3. Economic growth.