Stabilization policy: basic concepts, types, methods, goals

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:40

Stabilization policy is a macroeconomic strategy adopted by governments and central banks to maintain stable economic growth along with prices and unemployment. The current stabilization policy includes monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in the economy. The goal is to avoid unpredictable changes in total output as measured by gross domestic product (GDP) and large changes in inflation. Stabilization policies (the economy) tend to also lead to modest changes in the level of employment. It often lowers the unemployment rate.

Out of balance

This stabilization policy is budget-driven and aims to reduce fluctuations in certain areas of the economy (eg inflation and unemployment) in order to maximize the corresponding levels of national income. Fluctuations can be controlled through a variety of mechanisms, including policies that stimulate demand to combat high levels ofunemployment, and those that suppress demand to counter rising inflation.

Stabilization policy and economic recovery

Used to help an economy recover from a specific economic crisis or shock, such as sovereign debt defaults or a stock market crash. In these cases, stabilization policies may come from governments directly through open legislation and securities reforms, or from international banking groups such as the World Bank. The latter structure often contributes to the goals of stabilization policy.

Within Keynesian economics

Famous economist John Maynard Keynes theorized that when people within an economy do not have the purchasing power to purchase the goods or services that are produced, prices fall as a means to attract customers. As prices fall, businesses can suffer significant losses, leading to more corporate bankruptcies. Subsequently, the unemployment rate increases. This further reduces purchasing power in the consumer market, causing prices to fall again.

This process was considered cyclical in nature. Stopping it will require changes in fiscal policy. Keynes suggested that through policy making, the government could manipulate aggregate demand to reverse the trend.

State stabilizationpolicy is in high demand. Leading economists believe that as economies become more complex and advanced, maintaining stable price levels and growth rates is essential to long-term prosperity. When any of the above variables become too volatile, there are unintended consequences that prevent markets from operating at their optimal level of efficiency.

Most modern economies apply stabilization policies, with most of the work done by central banking bodies such as the US Federal Reserve Board. The stabilization policy is largely attributed to the modest but positive GDP growth seen in the United States since the early 1980s.

Methods

A stabilization policy is a package or set of measures introduced to stabilize a financial system or economy. The term can refer to policies in two different circumstances: business cycle stabilization and economic crisis stabilization. In any case, this is a form of discretionary policy.

"Stabilization" may refer to correcting the normal behavior of the business cycle, which contributes to greater economic stability. In this case, the term usually refers to the management of demand through monetary and fiscal policy in order to reduce normal fluctuations and output. This is sometimes referred to as keeping the economy in balance.

Policy changes in thesecircumstances tend to be counter-cyclical, offsetting projected changes in employment and output to increase short- and medium-term welfare.

The term can also refer to measures taken to deal with a specific economic crisis, such as an exchange rate crisis or a stock market crash, in order to prevent an economic expansion or recession.

A financial stabilization policy package is usually initiated by either a government, a central bank, or one or both of these institutions, acting in conjunction with international institutions such as the International Monetary Fund (IMF) or the World Bank. Depending on the goals to be achieved, this suggests some combination of restrictive fiscal measures (to reduce government borrowing) and monetary tightening (to support the currency). All these "packages" are the instruments of the stabilization policy.

Examples

Recent examples of such packages include international debt revisions (where central banks and leading international banks renegotiated Argentina's debt to allow it to avoid a general default) and IMF interventions in Southeast Asia (in the late 1990s) when several Asian economies faced financial turbulence. They were saved by the stabilization economic policy of the state.

This type of stabilization can be painful in the short term forcorresponding economy due to lower output and higher unemployment. Unlike business cycle stabilization policies, these changes are often pro-cyclical, reinforcing existing trends. While clearly undesirable, the policy is meant to be a platform for successful long-term growth and reform.

It has been argued that instead of imposing such a scheme after the crisis, the very "architecture" of the international financial system should be reformed to avoid some of the risks (such as hot cash flows and/or hedge fund activity) that some people have to destabilize economics of financial markets, which leads to the need for the introduction of stabilization policies and, for example, the intervention of the IMF. The proposed measures include a global Tobin tax on foreign exchange transactions across borders.

Israel example

An economic stabilization plan was implemented in Israel in 1985 in response to the difficult domestic economic situation in the early 1980s.

The years following the Yom Kippur War in 1973 were an economically lost decade as growth slowed, inflation soared, and government spending soared. Then in 1983, Israel suffered the so-called "stock banking crisis". By 1984, inflation reached an annual rate close to 450% and is projected to exceed 1,000% by the end of next year.

These steps, combined with the subsequent implementation of market-based structural reforms, successfully revived the economy, paving the way forpath to its rapid growth in the 90s. The plan has since become a model for other countries facing similar economic crises.

American Stabilization Act

The Economic Stabilization Act of 1970 (Title II publ. 91-379, 84 stat. 799 enacted August 15, 1970, formerly codified at 12 USC § 1904) was a United States law that allowed the president to stabilize prices, rents, wages, salaries, interest rates, dividends and similar transfers. It has established standards to guide wage levels, prices, etc., which will allow for adjustments, exceptions, and changes to prevent inequity, taking into account changes in productivity, cost of living, and other relevant factors.

An anti-recession cure

The US was in a recession caused by the Vietnam War and the energy crisis of the 70s, coupled with labor shortages and rising he alth care costs. Nixon inherited high inflation even though unemployment was low. Seeking re-election in the 1972 presidential election, Nixon vowed to fight inflation. He acknowledged that this would lead to job losses, suggested that it would be a temporary solution, but promised that much more would come in terms of change, hope and "workforce". Economists' opinions about whether this policy was justified or not are polar. Nevertheless, the stabilization economic policy is still widespread.

Fiscal policy

Fiscal policy has its impact on the efficiency of the national economy. This applies to goals such as high employment, a reasonable degree of price stability, the stability of foreign accounts, and acceptable economic growth rates. These macro goals cannot be materialized automatically. But this requires thoughtful and well-planned political leadership and packages.

In the absence of this, the economy becomes vulnerable to large fluctuations and can slip into sustained periods of unemployment or inflation. Unemployment and inflation could coexist, as they did in the 70s, or a painful measurement depression in the 30s.

In today's world of globalization and growing international dependency, the likelihood of transmitting instability throughout the country is higher.