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Fiscal Policy and Economic Stabilization

Fiscal Policy and Economic Stabilization

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In the 1930s, with the United States reeling from the Great Depression, the government began to use fiscal policy not just to support itself or pursue social policies but to promote overall economic growth and stability as well. Policy-makers were influenced by John Maynard Keynes, an English economist who argued in The General Theory of Employment, Interest, and Money (1936) that the rampant joblessness of his time resulted from inadequate demand for goods and services. According to Keynes, people did not have enough income to buy everything the economy could produce, so prices fell and companies lost money or went bankrupt. Without government intervention, Keynes said, this could become a vicious cycle. As more companies went bankrupt, he argued, more people would lose their jobs, making income fall further and leading yet more companies to fail in a frightening downward spiral. Keynes argued that government could halt the decline by increasing spending on its own or by cutting taxes. Either way, incomes would rise, people would spend more, and the economy could start growing again. If the government had to run up a deficit to achieve this purpose, so be it, Keynes said. In his view, the alternative -- deepening economic decline -- would be worse.

Keynes's ideas were only partially accepted during the 1930s, but the huge boom in military spending during World War II seemed to confirm his theories. As government spending surged, people's incomes rose, factories again operated at full capacity, and the hardships of the Depression faded into memory. After the war, the economy continued to be fueled by pent-up demand from families who had deferred buying homes and starting families.

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Next Article: Fiscal Policy in the 1960s and 1970s

This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.

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