How to Stimulate the Economy

720 Words2 Pages

In 1929 when the American economy slid into recession, economists primarily relied on the classical theory of economics that was based on a promise that the economy would self-correct in absence of government interference. However, no correction occurred and hence the recession deepened compelling the economists to revise the theory in order to come up with the one that allowed the government to correct inflation and recession in the economy. The growth of government since the 1930s has been accompanied by steady escalations in its spending. Nowadays, keeping the inflation and unemployment as low as possible are the two most important goals of the government as well as the Fed. Also, at the same time, the government and the Federal Reserve have to ensure that the country’s GDP increases at average of 3%. This can be achieved through the use of the fiscal and monetary policy. When used in the right manner or mix, these policies can stimulate the economy and slow it down when it heats up. The logic of this can be depicted by the Phillips curve that shows that expansion of wages in growing economies tends to more rapid than normal for a given period of time. A permanent balance between employment and inflation that often results in long-term prosperity can only be realized through implementation of the right policies. When the country’s economy is performing poorly; for instance, when there is high unemployment, interest rates are at almost zero, inflation is about 2% per year, and GDP growth is less than 2% per year, the fiscal and monetary policy can be used to adjust these numbers to somewhat acceptable limits. In such a scenario, an expansion in fiscal policy would suffice to correct unemployment and low GDP by encouraging gove... ... middle of paper ... ...o-GDP ratio, often expressed as a percentage, is a comparison of what the country owes to what it produces. It is the measure of a country’s ability to pay back its debt. A high debt-to-GDP ratio can make it hard for a country like United States to pay its external debts, and may lead creditors to seek higher interest rates when lending. This can affect the Fed’s ability to implement monetary and fiscal policies, for instance, it curtails the ability of the central bank to participate in open operation market. Consequentially, higher risk of default accompanies higher the debt-to-GDP ratio because the country might not pay its debt back. Currently, Americans are facing the threat of increased price inflation as the public debt (90 percent of the GDP) threatens to crowd out private investment and drive interest rates up, and thus leading to slowed economic growth.

Open Document