In every country, the government takes steps to help the economy achieve the goals of growth, full employment, and price stability. In the United States, the government influences economic activity through two approaches: monetary policy and fiscal policy. Through monetary policy, the government exerts its power to regulate the money supply and level of interest rates. Through fiscal policy, it uses its power to tax and to spend.
Monetary policy is exercised by the Federal Reserve System (“the Fed”), which is empowered to take various actions that decrease or increase the money supply and raise or lower short-term interest rates, making it harder or easier to borrow money. When the Fed believes that inflation is a problem, it will use contractionary policy to decrease the money supply and raise interest rates. When rates are higher, borrowers have to pay more for the money they borrow, and banks are more selective in making loans. Because money is “tighter”—more expensive to borrow—demand for goods and services will go down, and so will prices. In any case, that’s the theory.
Fiscal policy relies on the government’s powers of spending and taxation. Both taxation and government spending can be used to reduce or increase the total supply of money in the economy—the total amount, in other words, that businesses and consumers have to spend. When the country is in a recession, the appropriate policy is to increase spending, reduce taxes, or both. Such expansionary actions will put more money in the hands of businesses and consumers, encouraging businesses to expand and consumers to buy more goods and services. When the economy is experiencing inflation, the opposite policy is adopted: the government will decrease spending or increase taxes, or both. Because such contractionary measures reduce spending by businesses and consumers, prices come down and inflation eases.
The belief that governments should have a large say in choosing the “right” rate of growth has also led some writers to challenge the social and economic value of economic growth in an advanced industrial society. They attribute to growth such undesirable side effects of industrialization as traffic congestion, the increasing pollution of air and water, the despoiling of the landscape, and a general decline in man’s ability to enjoy the “real” amenities of life. As has been seen, growth is really a transformation whereby certain industries experience a rise in importance followed by an eventual decline as the market for their output becomes relatively saturated. Demand, relatively speaking, moves on to other types of industries and products. All of this naturally implies a reallocation of resources over time. The faster these resources move, other things being equal, the more rapidly can growth and transformation proceed. The argument can be recast in terms of this transformation. A slower rate of growth in per capita consumption will slow down the rate of transfer of resources, but it may also result in a more livable environment. The rate of growth of individual welfare, so measured as to take into account non-consumable amenities, may even be increased. Some argue that in a growth-oriented society wants are created faster than the industrial machine can satisfy them, so that people are more dissatisfied and insecure than they would be if growth were not given such a high value. It is held by some critics that, in modern industrial society, consumption exists for the sake of justifying production rather than production being carried out to satisfy consumer desires. These arguments are a powerful challenge to those who see growth as the most important economic goal of a modern society.