Question

Is there a trade-off between economic growth and stabilization policy? That is, do
policy changes designed to mitigate the downturns in the business cycle have an effect on long-
run economic growth, either positively or negatively? Support your answer carefully.

Answer 1

A stabilization policy refers to the actions taken by the Federal reserve to maintain a healthy level of economic growth with minimum changes in the price levels. The implementation of this policy requires a thorough analysis of the business cycle so as to control sudden changes in the demand. The implementation of stabilization policy is done either by increasing or by decreasing the interest rates. An increased interest rate is done to discourage borrowing and decreased to encourage borrowing.

                                    A business cycle refers to the state of a business which ranges from extremely expansionary stage to a recessionary one. When the business cycle is recessionary, the central bank adopts expansionary monetary policies and the government adopts expansionary fiscal policies so as to revert the trend. Expansionary monetary operations includes operations like open market operations, interest rate variations, reserve requirements where the central bank decreases the interest rates and reserve requirements so that more money is made available in the market so as to revert the trend of the economy. The expansionary fiscal policy includes operations like government buying of bonds where the money is inducted in to the economy

                                    The effects of these expansionary policies are advantageous to fuelling the economic growth in the short run. Since a lot of money is being introduced in to the market, normal economic functions will be brought back to normalcy and the business cycle will slowly move from recessionary to expansionary stage. But once the situation goes uncontrolled, beyond a point in the economy, it leads to a rise in the inflation where there will be a lot of money in the economy and hence the value of money decreases. This will further result in slowing down the valuable foreign trade and hence the economy will again be back to recessionary stages. Thus, expansionary policies should be well directed so that once the requirement is over, the money is again brought back to normalcy and doesn’t lead to stages like inflation of the economy.