The Government's Role in the Economy

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The Role of the National Government in the Economy


The U.S. has a capitalistic economic system.  This means buyers and sellers interact to set prices and wages with some regulation by the government.  The U.S. government’s role in the economy has changed drastically from their laissez-faire policy of the late 1800’s.  Starting with Franklin Roosevelt’s New Deal, which was enacted to rid the U.S. of the Great Depression, the government has assumed a much larger regulatory role in the economy.  Today, the political debate has centered around the extent to which the government should regulate the economy.  In general, the Democrats favor government’s continued regulation of the economy while the Republicans seek to limit government’s regulatory role.



LAISSEZ-FAIRE ECONOMICS:  Until the New Deal, the U.S. employed a system of laissez-faire capitalism.  The government felt that the free market economic system would operate best with little or no interference by government. 


KEYNESIAN ECONOMICS:  Franklin Roosevelt’s New Deal used the economic policies of John Maynard Keynes in an effort to rid the country of the Great Depression.  Keynes felt the government could help correct the economic problems of a nation by altering its spending, taxes, and borrowing policies. 


Keynes felt the government should spend more money than it receives in taxes during a recession or a depression ( is a business cycle contraction, a general slowdown in economic activity).  This extra influx of money would create jobs and stimulate demand causing the economy to strengthen. 


When there is a high rate of inflation (general price level rises, each unit of currency buys fewer goods and services -  reflecting an erosion in the purchasing power of money), Keynes recommended the government should spend less money then it receives in taxes.  This would reduce money in circulation. Lowering demand, which should reduce inflation.  Keynesian economics relies on the government to take an active role in the economy. 



SUPPLY SIDE ECONOMICS:  During the late 1970’s and early 1980’s, the U.S. economy was faced with stagflation (high unemployment and high inflation).  President Reagan used supply-side economics to stimulate the economy.  Under this plan, production of goods and services was seen as the key to lowering inflation and creating employment.  Reagan, under this plan: 1) reduced income tax percentages; 2) reduced government spending for social programs; and 3) reduced government regulation of business.  By 1988, employment increased and inflation was in check.  But, the national debt and yearly government deficit has increased sharply.



ENCOURAGING COMPETITION:  During the Progressive Movement, the Sherman Anti-Trust Act and the Federal trade Commissions were enacted to make monopolies illegal.  Also, the Interstate Commerce Commission and the Federal Communication Commission were created to regulate businesses and to guarantee fair prices.


PROTECTING WORKERS AND CONSUMERS:  State and federal governments have passed laws to protect workers and consumers in the marketplace.  The Pure Food and Drug Act was another progressive law which required manufacturers to list all ingredients on their labels.  The Occupational Safety and Health Act, passed in 1970, established an agency to monitor health and safety standards at the workplace.


REGULATING INTERNATIONAL TRADE:  The national government has the power to influence foreign trade by using its power to impose tariffs (a tax on imported goods.)  During the U.S. policy of laissez-faire, high tariffs were enacted to protect American jobs from foreign competition.  Today, however, lower tariffs have been used in order to stimulate world trade.


MONETARY POWERS:  The U.S. government can use its monetary policy to strengthen or “kick start” the economy.  The Federal Reserve Act created in 1913 established the Federal Reserve System.  Its major role is to lessen the ups and downs in the economic cycle.  Its chief power is in its ability to control the amount of money in circulation.  In times of recession or depression, the Federal Reserve lowers interest rates allowing businesses and consumers to borrow money more easily.  This causes demand for products to increase, thus stimulating employment.  In times of inflation, the Federal Reserve raises interest rates.  This lowers the amount of money borrowed by businesses and consumers causing demand to drop.



GROSS NATIONAL PRODUCT (GNP):  GNP is the total value of all goods and services produced in the U.S. in one year including:  consumer spending, business spending, and government spending.  The GNP needs to grow each year in order for the economy to remain healthy since this shows new businesses have been created and productivity has increased.


UNEMPLOYMENT RATE:  This rate determines the percentage of people who are actively looking for employment but have not found a job.  The U.S. considers a rate of 5% or less to be healthy in today’s economy.


NATIONAL DEBT:  The amount of money the U.S. government owes to various lending institutions in the United States and overseas.  A major goal of the President and Congress is to lower the national debt in order to guarantee a healthy economy for years to come.


INFLATION RATE:  This measure the increase in cost of goods and services.  A high inflation rate causes the spendable income of people to drop as prices rise faster than wages.  The government tries to keep inflation at a rate of 5% or lower.


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