LEARNING OBJECTIVES
After you have read this section, you should be able to answer the following questions:
What is stabilization policy?
What is monetary policy, and how was it used during the Great Depression?
What is fiscal policy, and how was it used during the Great Depression?
Understanding why the Great Depression occurred is certainly progress. But policymakers also wanted to know if there was anything that could be done in the face of this economic catastrophe. One of Keynes’ most lasting contributions to economics is that he showed how different kinds of economic policy could be used to assist economies that were stuck in recessions.
When markets are doing a good job of allocating resources, standard economic reasoning suggests that it is better for the government to stay out of the way. But when markets fail to allocate resources well, the government might be able to improve the overall functioning of the economy. The idea that markets left alone would coordinate aggregate economic activity is difficult to defend in the face of 25 percent unemployment of the labor force and a decline in economic activity of nearly 30 percent over a 4-year period. Thus the rationale for government intervention in the aggregate economy is that markets are failing to allocate resources properly, perhaps because prices and wages are sticky.
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