The following lesson will cover the ways in which the government protects the U.
S. economy and ensures stable economic growth. A short quiz will follow the lesson to check for your understanding.
Protecting the Economy
Rollercoasters are thrilling rides, but what keeps you in your seat and the cars on the tracks? Luckily, the laws of physics protect us from our untimely demise.
But we know from previous lessons that there’s another type of rollercoaster that we as a nation ride on every day – the U.S. economy.
Just as a real rollercoaster can be fun, yet scary at the same time, so too can the economy.The question that needs to be asked then is ‘What keeps the economic rollercoaster (we’ll call it the Econocrash) on the tracks?’ Well, the person in charge of making sure Econocrash runs smoothly is the U.S. government.
Luckily, the U.S. government has two powerful tools at its disposal to keep Econocrash from going ‘off the tracks.’ It does this by ensuring that those rises and falls in the economy do not happen too frequently or too intensely.To protect the economy, the U.S.
government can utilize its fiscal policy by raising or lowering taxes and/or increasing or decreasing spending, as well as use monetary policy, through the Federal Reserve, to buy and sell treasury bonds, change the reserve requirements in banks, and change the discount rate.
Purposes of Fiscal Policy
In order to make sure Econocrash runs smoothly, the U.S. government may first turn to its toolbox and use its fiscal policy to do three main things:The first is to stabilize the economy in a period of recession. A recession is two or more consecutive quarters in which the economy shrinks instead of grows.
So, on our Econocrash ride, fiscal policy attempts to bring the low dips up towards ground level. Because, let’s face it, Econocrash would get way too scary for people if they fell too far down for too long. We want everyone to enjoy the ride so the ride has to appeal to everyone, much like bringing the economy out of a recession would.The second way fiscal policy is used is to keep inflation low. Inflation is when prices of goods rise, but the value of money doesn’t keep up with that rise.
For example, let’s say the cost to ride Econocrash was $1 today, but next year the cost will rise to $1.50, and, unfortunately, the amount of money from your paycheck that you use to pay for a ticket onto Econocrash has remained unchanged. So, in effect, you are getting less for your money because it costs more to do the same thing, and you don’t have more money to do it.The government also needs money to do things and gets that money when citizens spend money and pay taxes on those goods. Thus, the government uses fiscal policy to ensure that citizens have money to buy goods, which in turn generates tax revenue. The government does this by keeping demand for those goods in check, which stabilizes their prices.
In other words, there can only be so many tickets available to ride Econocrash at any given time or else ticket prices would spike or plummet or lines could get too long and then Econocrash would fail to be an exciting ride. The money that the government collects from Econocrash tickets also helps maintain the ride.Lastly, the last way the government uses fiscal policy to protect the economy and keep Econocrash running smoothly is by stabilizing economic growth to prevent boom and bust cycles.
While riding Econocrash, being up high on one of those hills is a great feeling and the same can be said of our economy when it is riding a giant wave of prosperity. However, tall hills also mean big falls, which we don’t want. The government, in turn, tries to keep the economy’s expectations in check so that we don’t have the thrilling highs (booms) followed by the depressing falls (or busts).
Purposes of Monetary Policy
Econocrash can’t run smoothly on fiscal policy alone; it often needs the help of a marketing crew, in the shape of the Federal Reserve, to ensure that people come to ride Econocrash and do so responsibly. The Federal Reserve uses monetary policy in ways that are very similar to the ways in which fiscal policy is used.
The goals of using monetary policy are to promote:
- Maximum employment
- Stable prices
- Moderate long-term interest rates
By implementing effective monetary policy, the Fed can maintain stable prices, thereby supporting conditions for long-term economic growth. In other words, the price to buy a ticket to ride Econocrash will always be affordable and everyone will be able to ride on it if they choose. Also, it goes without saying that people need to work to be able to afford a ticket in the first place, so it is in the Fed’s best interest to make sure as many people as possible have jobs to buy their tickets.The Fed also helps Econocrash run smoothly by ensuring that there is enough money and credit to sustain economic growth without inflation.
So, in this way, people will be able to make enough money to buy a ticket to ride Econocrash, and the price of that ticket will not increase too rapidly in the future. If there is an indication that inflation is threatening our purchasing power because it is too high, the Fed may need to slow the growth of the money supply.Lastly, the Fed needs to perform maintenance on Econocrash from time to time and repairs cost money. By keeping moderate long-term interest rates the Fed can offer discounted rides to customers, who are the banks, in the hopes that they spread the word to others to want to ride Econocrash or build their own rollercoasters. In our economy, moderate long-term interest rates make banks, businesses, and individuals want to take out loans and create healthy investments that will sustain the economy.
The U.S. government uses both fiscal and monetary policy to protect our economy and promote long-term economic growth. The protections that fiscal policy provides are help in a recession, keeping inflation in check, and preventing boom and bust periods in the economy. Monetary policy also provides the protections of promoting maximum employment, stable prices, and moderate long-term interest rates.
This lesson will provide the information you need to know to:
- Discuss the purposes of fiscal and monetary policy
- Contrast recession and inflation
- Comprehend the importance of promoting employment, prices and interest rates in order to protect the economy