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Study GuideAmerican Government–Economic Policy1.The Goals of Economic PolicyU.S.economic policyis designed to promote a healthy economy that benefits the broadest possiblerange of Americans. Achieving this goal is difficult because economic decisions almost always involvetradeoffs: a policy that helps one group or goal may harm another. As a result, compromise is centralto economic policymaking.The federal government focuses onthree primary economic goals, along with several secondaryobjectives.1.1The Three Primary Goals1. Stable PricesStable pricesmean keeping inflation low and predictable.•Inflationoccurs when prices for goods and services rise, reducing the purchasing power ofmoney.•When inflation is high, wages often fail to keep up, making people effectively poorer.•Some causes of inflation arebeyond government control, such as:oNatural disasters (droughts or freezes affecting crops)oSharp increases in oil prices, which raise transportation and production costseconomy-widePolicymakers often raiseinterest ratesto reduce inflation, but doing so can slow businessinvestment and increase unemployment.2. Full EmploymentFull employmentdoes not mean zero unemployment.•A4% unemployment rate or loweris generally considered full employment.•Some unemployment is unavoidable because people:

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Study GuideoChange jobsoEnter or leave the workforceoAre temporarily unable to workUnemployment rates vary by region and industry. For example, California’s unemployment exceededthe national average in the early 1990s due to defense-industry cutbacks and business relocation.Low unemployment strengthens workers’ bargaining power, but it can also contribute to inflation ifdemand for labor pushes wages higher.3. Economic GrowthEconomic growthis measured byGross Domestic Product (GDP)—the total value of goods andservices produced in the U.S.•Strong growth: around4% per year•Weak or stagnant growth:below 1% per yearConsequences of weak growth include:•High unemployment•Low productivity•Fewer job opportunitiesArecessionis defined astwo consecutive quarters of negative GDP growth.A notable exception to normal economic patterns occurred in the 1970s, when the U.S. experiencedstagflation—a rare combination ofhigh inflation and high unemployment.1.2Tradeoffs in Economic PolicyEconomic goals often conflict:•High interest rates→lower inflation, but higher unemployment•Low interest rates→more growth and hiring, but higher inflationBecause of these tensions, policymakers must accept tradeoffs—such as tolerating moderate inflationto encourage business expansion.

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Study Guide1.3AddiƟonal Economic ObjecƟvesBeyond the three main goals, the federal government also seeks:•Low or stable interest rates•Abalanced budgetor reduced budget deficit•A favorabletrade balancewith other countriesThese goals further complicate policymaking, since progress in one area can undermine another.Key TakeawayEconomic policymaking is a balancing act. The federal government constantly negotiates amongcompeting goals—stable prices, full employment, and economic growth—while managinginflation, unemployment, interest rates, deficits, and trade. Because no single policy can maximize allgoals at once, compromise and tradeoffs are unavoidable.2.Theories of Economic PolicyWhen governments design economic policy, they rely heavily oneconomic theories—frameworksthat explain how the economy works and what role the government should play in it. Economists oftendisagree, which is why economic policy is frequently controversial and subject to change.Below are the four major economic theories that have shaped U.S. policymaking.2.1Laissez-Faire EconomicsKey thinker:Adam SmithMajor work:The Wealth of Nations(1776)•Laissez-fairemeans “to leave alone.”•The government shouldnot interferein the economy.•Supports:oLow taxesoFree tradeoMinimal regulation•Assumes the economy isself-correctingthrough the “invisible hand” of the market.

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Study GuideThis theory dominated economic thinking for much of the 18th and 19th centuries and still influencesarguments for limited government today.2.2Keynesian Economic TheoryKey thinker:John Maynard KeynesMajor work:The General Theory of Employment, Interest, and Money(1936)•Developed during theGreat Depression.•Argues that economic downturns are caused byinsufficient consumer demand.•When demand falls:oBusinesses cut productionoWorkers are laid offoDemand falls further (a downward spiral)Solution: Fiscal Policy•Increasegovernment spending•Cuttaxes•Put money directly into the economy to stimulate demandPresidentFranklin D. Roosevelt’s New Dealreflected Keynesian ideas:•Government became the “employer of last resort”•Programs like theCCCandWPAprovided jobsWhile these programs eased suffering, full recovery came largely throughWorld War II defensespending.2.3MonetarismKey thinker:Milton Friedman•Rose in popularity in the late 1970s and early 1980s.•Criticized Keynesian economics for encouraging excessive government intervention.•Argues that inflation and economic instability are caused bypoor control of the moneysupply, not weak demand.

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