THE PRACTICAL PROBLEMS OF STABILIZATION

In principle, monetary-fiscal policy to smooth out booms and depressions and to keep aggregate demand ona stabk growth path is simple. But will it really work?

The first thing to note is that there isn’t much evidence yet. We have had only about three decades of experience with conscious fiscal policy. Congressional and public opinion have only gradually accepted the idea of countercyclical budget policy, and advocates of an annually balanced budget are still powerful. Thus fiscal policy has been controversial, halting, and spotty—far from the orderly plan laid out by the functional-finance programers. Even monetary policy has been used in a modern vein only recently.

The results thus far have been mixed. Chalk up the 1930’s as poor, but hardly a reasonable test of combined monetary-fiscal policy; the 1940’s and ‘50’s as so-so; and the 1960’s as definitely promising. Three decades is a very short period, and it would be surprising if our new stabilization tools had proved fully successful in their trial run, especially with such an unsystematic trial period. The World War II experience did demonstrate unmistakably the enormous expansionary power of large-scale deficit spending financed by bank credit. And since 1940 there has been no major recession—the longest generally prosperous period in our history. But we have had some inflation and nagging unemployment during much of the last decade.

This chapter looks at four important practical problems we face in trying to stabilize the growth rate of the economy through monetary and fiscal policy.