E CS 08

Government and the Economy

The health of a nation’s economy is influenced by governmental policy. Fiscal policy can be used to spur economic growth. Monetary policy can be used to moderate fluctuations in the business cycle.

Content Statement

8. Economic policy decisions made by governments result in both intended and unintended consequences.

Content Elaborations

Economic policy decisions are generally intended to maintain a healthy economy. Examples include social security, deep ocean drilling, tax cuts and deficit spending. Sometimes there are unintended consequences.

The historic controversy over tariffs is an example of unintended consequences. The Hawley-Smoot Tariff of 1930 was protectionist legislation pushed by manufacturers and farmers. The tariff made it difficult for European producers to sell their products to the U.S. Consequently, the former European allies could not repay war debts and international trade stagnated.

One of several factors leading to the Great Depression in the United States was the excessive amount of lending by banks. This fueled speculation and use of credit. The Federal Reserve attempted to curb these practices by constricting the money supply. The effect was to worsen economic conditions by making it harder for people to repay debts and for businesses, including banks, to continue operations.

Government regulations have a specific intent. Some would argue, however, that the unintended consequences outweigh the benefits of the intentions of the regulations.

Fiscal policies are decisions to change spending and tax levels by the federal government to influence national levels of output, employment and prices.

Increasing federal spending and/or reducing taxes may promote more employment and output in the short run, but price levels and interest rates could rise as a result. Similarly, decreasing federal spending and/or increasing taxes will likely lead to lower price levels and interest rates, but in the short run, they decrease employment and output levels.

The Federal Reserve System uses monetary policies to influence the supply of money and the availability of credit. The Fed induces changes in interest rates to influence prices, employment and spending.

Expectations for Learning

Describe the intended and unintended results of an economic policy decision made by a government.