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American Government - Economic Policy

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    Study Guide American Government – Economic Policy 1. The Goals of Economic Policy U.S. economic policy is designed to promote a healthy economy that benefits the broadest possible range of Americans. Achieving this goal is difficult because economic decisions almost always involve tradeoffs : a policy that helps one group or goal may harm another. As a result, compromise is central to economic policymaking. The federal government focuses on three primary economic goals , along with several secondary objectives. 1.1 The Three Primary Goals 1. Stable Prices Stable prices mean keeping inflation low and predictable. • Inflation occurs when prices for goods and services rise, reducing the purchasing power of money. • When inflation is high, wages often fail to keep up, making people effectively poorer. • Some causes of inflation are beyond government control , such as: o Natural disasters (droughts or freezes affecting crops) o Sharp increases in oil prices, which raise transportation and production costs economy - wide Policymakers often raise interest rates to reduce inflation, but doing so can slow business investment and increase unemployment. 2. Full Employment Full employment does not mean zero unemployment. • A 4% unemployment rate or lower is generally considered full employment. • Some unemployment is unavoidable because people:

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    Study Guide o Change jobs o Enter or leave the workforce o Are temporarily unable to work Unemployment rates vary by region and industry. For example, California’s unemployment exceeded the 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 if demand for labor pushes wages higher. 3. Economic Growth Economic growth is measured by Gross Domestic Product (GDP) — the total value of goods and services produced in the U.S. • Strong growth: around 4% per year • Weak or stagnant growth: below 1% per year Consequences of weak growth include: • High unemployment • Low productivity • Fewer job opportunities A recession is defined as two consecutive quarters of negative GDP growth . A notable exception to normal economic patterns occurred in the 1970s, when the U.S. experienced stagflation — a rare combination of high inflation and high unemployment . 1.2 Tradeo ff s in Economic Policy Economic goals often conflict: • High interest rates → lower inflation, but higher unemployment • Low interest rates → more growth and hiring, but higher inflation Because of these tensions, policymakers must accept tradeoffs — such as tolerating moderate inflation to encourage business expansion.

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    Study Guide 1.3 Addi Ɵ onal Economic Objec Ɵ ves Beyond the three main goals, the federal government also seeks: • Low or stable interest rates • A balanced budget or reduced budget deficit • A favorable trade balance with other countries These goals further complicate policymaking, since progress in one area can undermine another. Key Takeaway Economic policymaking is a balancing act. The federal government constantly negotiates among competing goals — stable prices, full employment, and economic growth — while managing inflation, unemployment, interest rates, deficits, and trade. Because no single policy can maximize all goals at once, compromise and tradeoffs are unavoidable. 2. Theories of Economic Policy When governments design economic policy, they rely heavily on economic theories — frameworks that explain how the economy works and what role the government should play in it. Economists often disagree, 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. 2.1 Laissez - Faire Economics Key thinker: Adam Smith Major work: The Wealth of Nations (1776) • Laissez - faire means “to leave alone.” • The government should not interfere in the economy. • Supports: o Low taxes o Free trade o Minimal regulation • Assumes the economy is self - correcting through the “invisible hand” of the market.

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    Study Guide This theory dominated economic thinking for much of the 18th and 19th centuries and still influences arguments for limited government today. 2.2 Keynesian Economic Theory Key thinker: John Maynard Keynes Major work: The General Theory of Employment, Interest, and Money (1936) • Developed during the Great Depression . • Argues that economic downturns are caused by insufficient consumer demand . • When demand falls: o Businesses cut production o Workers are laid off o Demand falls further (a downward spiral) Solution: Fiscal Policy • Increase government spending • Cut taxes • Put money directly into the economy to stimulate demand President Franklin D. Roosevelt’s New Deal reflected Keynesian ideas: • Government became the “employer of last resort” • Programs like the CCC and WPA provided jobs While these programs eased suffering, full recovery came largely through World War II defense spending . 2.3 Monetarism Key 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 by poor control of the money supply , not weak demand.

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