Question

Is it appropriate for our government to try to smooth out the excesses of the business cycle? Or should it be allowed to fluctuate freely without interference? Please explain your thinking. What do you think macroeconomy might look like without stabilization policy.

Answer 1

It is necessary for the government to intervene and smooth out fluctuations in the economy with its stabilizing policies. When there are fluctuations in business cycles like recession or inflation it is very hard for the market to remove these fluctuations on its own because they are widespread over the whole economy and they are intense. Thus, the only solution is for the government and central bank to intervene and apply the fiscal policies and monetary policies respectively.

The government uses fiscal policies for stabilizing business cycle fluctuations, which includes changes in government spending and taxation. At times of recession, the government uses expansionary fiscal policy in which it increases government spending and reduces taxes. Because of this, the economy gets a boost in production and consumption and the economy gets back to normal. At times of inflation, the government uses contractionary fiscal policy in which it decreases government spending and increases taxation.

Inflation is the situation where there is an excess of money in the economy and in the hands of people which leads to higher aggregate demand and high prices in the economy. Thus, the contractionary fiscal policy leads to a reduction in the consumption level (by reducing government spending and increasing taxes) which leads to a fall in aggregate demand and thus the fall in prices.

Thus, without government policies, these fluctuations that have such an impact on the economy cannot be stabilized.