chapter 17: stabilizing the national economy - dpisd. · pdf filewhat are two problems the ......

Why It’s ImportantWhy is it important for the econ-omy to be balanced, or stabilized?This chapter will explain the factorsthat destabilize the economy, andwhat actions are taken to adjust it.

To learn more aboutunemployment andinflation, view theEconomics & You

Chapter 23 video lesson: EconomicGrowth and Stability

Chapter Overview Visit the Economics Today and Tomorrow Web site at tx.ett.glencoe.com and click on Chapter 17—Chapter Overviewsto preview chapter information.

http://www.glencoe.com/sec/socialstudies/economics/econtt2003/tx/chapter17/overview.shtml

451Stabi l iz ing the Nat ional Economy

Terms to Know• stabilization policies• unemployment rate• full employment• underground economy• demand-pull inflation• stagflation• cost-push inflation

Reading Objectives1. What are two problems the

government faces in mea-suring unemployment?

2. What are the four kinds ofunemployment?

3. How does demand-pullinflation differ from cost-push inflation?

READER’S GUIDE

1

KIPLINGER’S PERSONAL FINANCE MAGAZINE, SEPTEMBER 1998

A booming economy. Record-low unemployment. A blizzard of pink slips [a note stating that a personhas been fired].

What’s wrong with this picture? The fact is, evenin the best of times hundreds of thousands of people

lose their jobs through nofault of their own. . . . Youmight not get any advancewarning, so don’t becaught off guard. Have anup-to-date resume andnetworking system. . . .You want to be able to

launch your job search soonafter you get the bad news.

When people are unemployed, they experience uncer-tainty. In the same way, unemployment in generalcauses uncertainty in the American economy. To keep

the economy healthy and to make the future more predictable forplanning, saving, and investing, the federal government uses mon-etary and fiscal policies. Together these are called stabilizationpolicies. Unfortunately, neither policy is always successful in

stabilization policies: attemptsby the federal government to keepthe economy healthy; includesmonetary and fiscal policies

1925 ’95’90’30 ’35 ’65 ’70 ’75 ’80 ’85’40 ’45 ’50 ’55 ’60 2000

Perc

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ivil

ian

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30

25

20

15

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YearSource: Standard & Poor’s

The Unemployment Rate

CHAPTER 17

solving the complex problems of the economy. As you read this section, you’lllearn that two of the biggest threats to a nation’s economic stability are highunemployment and inflation.

MeasuringUnemployment

Expert economists advise the Presidentand Congress, but they often disagree

about the causes and cures of the economic problems that peri-odically face the nation. One statistic they all look at, however, is the unemployment rate—the percentage of the civilian laborforce that is without jobs but that is actively looking for work. See Figure 17.1.

High unemployment is usually a sign that all is not well withthe economy. Moreover, the waste of human resources that unem-ployment causes is an extremely serious problem. As a result,maintaining a low unemployment rate is one of the major goals instabilizing the economy.

UnemploymentUnemployment can reduceliving standards, disruptfamilies, and reduce a per-son’s feeling of self-respect.During which year showndid unemployment peak?

unemployment rate: percentageof the civilian labor force that isunemployed but is actively look-ing for work

FIGURE 17.1FIGURE 17.1

452

For an online update of this graph, visit tx.ett.glencoe.com and click on Textbook Updates—Chapter 17.

Student Web Activity Visit the Economics Today and Tomorrow Web site at tx.ett.glencoe.comand click on Chapter 17—Student WebActivities to learn how to write an online resume.

http://www.glencoe.com/sec/socialstudies/economics/econtt2003/tx/chapter17/webact.shtml

http://www.glencoe.com/sec/socialstudies/economics/econtt2003/tx/chapter17/txtupdate.shtml

Types of Unemployment Many types of unemploymentexist. Figure 17.2 describes these kinds of unemployment.Some people work in seasonal jobs or jobs that are sensitive totechnological advances or to changes in the marketplace. As aresult, not all unemployment can or should be eliminated.Moreover, economists disagree over what the level of full employ-ment should be. Economists today generally have come to con-sider the economy at full employment when the unemploymentrate is less than 5 percent.

It is important to remember that the unemployment rate isonly an estimate. The unemployment rate does not includepeople who are unemployed and have stopped looking for work.Nor does it include people who work in family businesses with-out receiving pay.

Unemployment is difficult to measure accurately becausegovernment statisticians cannot possibly interview every personin and out of the labor force. Survey results are also imperfectbecause of the existence of the underground economy. Theunderground economy consists of people who do not follow federaland state laws with respect to reporting earnings. Examples mightinclude tax avoiders, gamblers, and drug traffickers.

full employment: condition ofthe economy when the unemploy-ment rate is lower than a certainpercentage established by econo-mists’ studies

underground economy: trans-actions by people who do not fol-low federal and state laws withrespect to reporting earnings


Types of Unemployment

Type

Cyclical

Structural

Seasonal

Frictional

Definition

Unemployment associated with up ordown fluctuations in the business cycle

Unemployment caused by changes inthe economy, such as technologicaladvances or discoveries of naturalresources

Unemployment caused by changes inthe seasons or weather

Temporary unemployment between jobsbecause of firings, layoffs, voluntarysearches for new jobs, or retraining

Characteristics

Rises during recessions and depressions;falls during recoveries and booms

Can result when workers are replaced bycomputers or other machines or whencheaper natural resources are found else-where; often affects less skilled workers

Affects construction workers, particularlyin the Northeast and Midwest; also affectsfarmworkers needed only during certainmonths of the growing season

Always exists to some degree because ofthe time needed between jobs to findnew work and the imperfect matchbetween openings and applicants


454 CHAPTER 17

demand-pull inflation: theorythat prices rise as the result ofexcessive business and con-sumer demand; demandincreases faster than total supply,resulting in shortages that lead tohigher prices

InflationA second major problem that

may face any nation is inflation.The economy can usually adapt togradually rising prices. If prices riseabout 3 percent every year, forexample, everyone comes to expectand understand that. Unpredictableinflation, however, has a destabiliz-ing effect on the economy.

During periods of unpre-dictable high inflation, creditorsraise interest rates to maintain thelevel of profits they had beforeinflation began to rise rapidly.This, in turn, may have a slowingeffect on the economy’s growth.

Inflation may also affect con-sumers’ standard of living.

Suppose you receive a 5 percent pay raise in a year in which infla-tion has risen 8 percent. Your real (adjusted for inflation) incomehas decreased. Inflation is a particularly serious problem for peo-ple who live on fixed incomes, such as those who are retired.

Not all economists agree on a single explanation of why infla-tion occurs. Two competing ideas have developed: the demand-pulltheory (prices are pulled up by high demand) and the cost-pushtheory (prices are pushed up by high production costs and wages).

Demand-Pull According to the theory of demand-pull inflation,prices rise as the result of excessive business and consumerdemand. If economy-wide, or aggregate, demand increases fasterthan total supply, the resulting shortage will lead to the biddingup of prices.

Demand-pull inflation can occur for several reasons. If theFederal Reserve causes the money supply to grow too rapidly,individuals will spend the additional dollars on a limited supplyof goods and services. This increased demand will cause prices torise. Increases in government spending and in business invest-ment can also increase overall demand. Aggregate demand canalso increase if taxes are reduced or consumers begin saving less.

Cost-Push The demand-pull theory assumes that increaseddemand will increase output and reduce unemployment. Expe-rience, however, has shown that rising prices and unemployment

How do United States unemployment statisticscompare to those of other industrialized nations?

Unemployment

Unemployment Rate

U.S. Japan France Germany

4.2% 4.7% 11% 10.5%

48% 51% 58% 36%

6 mo. 1 yr. 2 yrs. 5 yrs.

% of Average Wage Received in Benefits

Length of Time Benefits Are Paid

Source: The World Factbook, 2000


Effects of Inflation As Ziggy notes, inflation lowers thepurchasing power of people, especially those on fixed incomes.

17.317.3

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Understanding Key Terms1. Define stabilization policies, unemployment

rate, full employment, underground economy,demand-pull inflation, stagflation, cost-pushinflation.

Reviewing Objectives2. What are two problems the government faces in

measuring unemployment?

3. Graphic Organizer Create a diagram like the one below to describe the four kinds ofunemployment.

4. How does demand-pull inflation differ from cost-push inflation?

Applying Economic Concepts5. Inflation and Deflation Name some factors

that could cause the price of each of the follow-ing to go up or down: oil, medical care, orangejuice, automobiles.

Types ofUnemployment

6. Understanding Cause and EffectConstruct a table that identifies the causes ofinflation. List four causes under demand-pullinflation in column 1 and three causes undercost-push inflation in column 2. For help inconstructing tables, see page xvii in theEconomic Handbook.

Critical Thinking Activity

Practice and assesskey skills with

Skillbuilder InteractiveWorkbook, Level 2.

1

can occur at the same time. This combination of inflation and low economic activity is sometimescalled stagflation.

According to some economists, stagflation is aresult of cost-push inflation at work in the economy.The theory of cost-push inflation states that the wagedemands of labor unions and the excessive profit motive of largecorporations push up prices. When businesses have to pay higherwages, their costs increase. To maintain their profit level, businessesmust raise the prices of the goods and services they produce.

During periods of cost-push inflation, unemployment canremain high. Prices are being adjusted for higher wages and prof-its—not because of increased aggregate demand. Without addi-tional aggregate demand, producers have no reason to increaseoutput by hiring new workers.

stagflation: combination of infla-tion and low economic activity

cost-push inflation: theory thathigher wages and profits push upprices

Univ

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ed.

SPOTLIGHT ON THE ECONOMY

Employers across the country are facinga newly emboldened American work

force. We’re living through the tightest U.S.labor market in three decades—a hiringbonanza that is transforming the nature of

work. The current hypergrowth in jobscan’t last forever; fast-food restaurantswon’t be paying signing bonusesduring the next recession. But themost remarkable changes in theworkplace—and our attitudestoward it—will redefine careerswell into the 21st century. Just asthe Great Depression produceda generation of frugal worry-

warts, those of us benefitingfrom the long jobs boom of the

1990s sport an often brazen self-confidence about how we connect to our jobs. . . .

What is worth knowing? That moreAmericans are creating entirely new styles ofemployment. They’re found in the expandingranks of self-employed Free Agents who findfinancial and professional independence ineverything from personal training to urbanplanning. Or they are the new Nomads, workers

who never seem to stop jobhunting. There’s an emergingclass of Globalists, too—thosehave-laptop-will-travel workerswho straddle time zones in today’sborderless economy. . . .

The most striking—and frightening—feature of this new landscape is how much itdemands of us. Once expertise in a single disci-pline, like marketing, was enough to ensure asecure corporate future. But today’s free agentneeds skills in selling himself (how else todrum up business?), finance (to win that bankloan) and technology (is this computer upgradea wise investment?).—Reprinted from February 1, 1999 issue of Business Week by special

permission, copyright © 1999 by The McGraw-Hill Companies, Inc.

Think About It1. According to the article, why are workers so confi-

dent about their jobs?

2. How have the new styles of employment changedwhat is demanded of workers?

Check It Out! In this chapter you learned about the fourkinds of unemployment. In this article, read to learnhow the United States job market looked at the end ofthe twentieth century.

Your Next JobYour Next Job

456 CHAPTER 17


Terms to Know• fiscal policy• circular flow of income

Reading Objectives1. How does income flow

between businesses andconsumers?

2. How can the federal gov-ernment use fiscal policy tocombat unemployment?

READER’S GUIDE

Most economists belong to one of two groups on thequestion of stabilization. One group emphasizes therole of the Federal Reserve in stabilizing the economy,

which you learned about in Chapter 15. In this section, you’lllearn that the other group concentrates more on the use of fiscalpolicy, the federal government’s deliberate use of its taxationrates and expenditures to affect overall business activity.

John Maynard KeynesJohn Maynard Keynes developed fiscal policy theories during

the Great Depression. Keynes believed that the forces of aggregatesupply and demand operated too slowly in a serious recession, andthat government should step in to stimulate aggregate demand.

2

fiscal policy: federal govern-ment’s use of taxation and spend-ing policies to affect overallbusiness activity

THE NEW YORK TIMES, JULY 14, 1999

For all the recent talk of cutting taxes, Congressrarely cuts them when the economy is growingrobustly, as it is now, and unemploymentis low. The worry among economists is

that the extra money in people’s pock-ets may make an already strongeconomy too strong, finally stokinginflation after a long period of rela-tively stable prices.

circular flow of income: eco-nomic model that pictures incomeas flowing continuously betweenbusinesses and consumers

The Circular Flow of IncomeTo understand Keynesian theory, you must first understand

what is known as the circular flow of income. You learnedabout this model in Chapter 2. The model pictures income asflowing from businesses to households as wages, rents, interest,and profits. Income flows from households to businesses as pay-ments for consumer goods and services.

Not all income, however, follows this circular flow. Some of itis removed from the economy through consumer saving and gov-ernment taxation. Economists use the term leakage to refer tothis removal of money income. Figure 17.4 shows these leak-ages. Offsetting leakages of income are injections of income intothe economy. Injections occur through business investment andgovernment spending.

Consumers

Banks & OtherFinancial

Institutions

FederalGovernment

Businesses

LeakagesInjectionsPurchases of Goods and Services

Income (Wages, Rents, Interest, Profits)

The Circular Flow of Income

Taxe

s Taxes

for

Investment

Savi

ng

Borrow

ing

GovernmentSpending

(Purchases of Goods & Services,

Interest)

Government Spending

(Wages, Transfer Payments,

Interest)GovernmentBorrowing

Circular Flow Government occupies a central position in the circular flow ofincome. By using fiscal policy, the federal government partially controls the levels of leak-ages and injections. This, in turn, may control the overall level of economic activity.


CHAPTER 17458


FRANK & ERNEST

Ideally, leakages and injections balance each other. See Figure17.5. In this state of equilibrium, the income that householdssave is reinjected through business investment. Income taken outthrough taxes is returned through government spending.

Fiscal Policy and UnemploymentMany public officials and labor leaders have suggested starting

jobs programs to reduce unemployment and stimulate the econ-omy. Several suggestions for forming new government-sponsoredjobs programs to bring down unemployment rates were made inthe early 1980s and again in 1992 and 1993.

Cuts in federal taxes are another way in which fiscal policyhas been used in an attempt to speed up economic activity andfight unemployment. Giving businesses tax credits on invest-ments allows them to deduct from their taxes some of the costsof new capital equipment. The goal is to encourage businesses to expand production and hire more workers.

Fiscal Policy and InflationFiscal policy supporters also believe that inflation can be

reduced by such government actions as increasing taxes and/orreducing government spending. They argue that such actions willreduce the aggregate demand for goods and services. Because peo-ple are paying higher taxes, they are taking home less spendableincome and so must cut back on their purchases. As purchases

Equilibrium The customer above is unhappy that his income and outgoare in equilibrium. Keynesian economists, however, want injections and leak-ages (income and outgo) to balance in the circular flow of economic activity.

17.517.5

FRANK & ERNEST reprinted by permission of Newspaper Enterprise Association, Inc.

460 CHAPTER 17

Jobs programs were created by the federal government during the 1930s.

The Federal Art Project employed artists todepict American history and everyday life inpublic buildings. These artists created morethan 2,500 murals and 17,700 sculptures.

The Federal Writers Project employedwriters who worked on many different publi-cations. The best known was the AmericanGuide series—tour guides that included infor-mation on the history, geography, industry,and culture for each of the 48 states. ■

Economic Connection to...Economic Connection to...


Jobs Programs

decline, businesses will cut back on production. Thisreduction in demand will cause businesses to recon-sider raising prices, thus curbing inflation.

Often, however, as inflation falls, unemploymentrises slightly because of less business activity.Therefore, fiscal policy as a means of reducing inflation has not beenused frequently.

Understanding Key Terms1. Define fiscal policy, circular flow of income.

Reviewing Objectives2. Graphic Organizer Create a diagram like the

one below to show what types of income flowfrom businesses to consumers in the circular flow.

3. How can the federal government use fiscal policy to combat unemployment?

Applying Economic Concepts4. Fiscal Policy Explain how the government pol-

icy of increasing federal, state, or local taxescould eventually lower inflation.

Businesses Consumers



2

5. Evaluating Primary and SecondarySources Research the Depression-era writings of Studs Terkel and photographs ofDorothea Lange. Write a report describingthe economic conditions of the early 1930sand what actions you think the governmentshould have taken to ease the crisis.

History

CCC and WPA posters

Jobs Programs


Have you ever read something and just a short time later forgotten what it was all about? Summarizinginformation—reducing many sentences to just a few well-chosen phrases—helps you remember the mainideas and important facts contained in a longer reading selection.

Critical Thinking Skills

Practicing the Skill

Read the excerpt below, then answer the questions.

“Tomorrow’s school, it turns out, may remind parentsmore of a sleek shopping mall than of the long, chalk-choked corridors of their youth. Retailers and health clubsof today ‘have got it figured out,’ says Paul Hansen, theprincipal architect in charge of a $118 million retrofit ofSandburg High School [Chicago]. The new Sandburg willincorporate some of the hottest ideas in school design: acentral library that resembles a Barnes & Noble super-store, a gym with updated amenities like a rock-climbingwall, and a food court to replace the cafeteria. . . . Schoolsof the future will be wired to the hilt. Fiber optics, inter-nal computer networks, videoconferencing, and the likeare musts.”—Newsweek, December 14, 1998

1. What is the main idea of this paragraph?2. What are the supporting details of the main idea?3. Write a short summary that will help you remember

what the paragraph is about.

Application Activity

Spend 15 minutes reading and summarizing twoarticles on the front page of today’s newspaper. Circlethe articles and have a classmate ask you questionsabout them. How much were you able to rememberafter summarizing the information?

Summarizing Information

• Your summary should bemuch shorter than thereading selection.

• Your summary shouldcontain the main ideas ofthe reading selection.

• Your summary should notcontain your opinion. Itshould contain only theopinion of the personwho wrote the selection.

• Your summary sentencesand phrases should notbe copied word for wordfrom the selection. Write asummary in your ownwords to be sure that youunderstand the mainideas of the selection.



Learning the Skill

To learn how to summarize information, follow theguidelines listed on the left.

monetarism: theory that dealswith the relationship between theamount of money the Fed placesin circulation and the level ofactivity in the economy

monetarists: supporters of thetheory of monetarism, oftenlinked with Milton Friedman

462 CHAPTER 17

Terms to Know• monetarism• monetarists• monetary rule• time lags

Reading Objectives1. What do monetarists think

the government and theFed should do to stabilizethe economy?

2. Why do monetarists criti-cize fiscal policy?

READER’S GUIDE

In this section, you’ll learn about monetarism, the theory thatdeals with the relationship between the amount of money theFederal Reserve places in circulation and the level of activity in

the economy. The supporters of this theory are called monetarists.

The Theory of MonetarismMonetarism is often linked with economist Milton Friedman

(see page 466). As you remember from Chapter 15, the FederalReserve can change the growth rate of the money supply.Friedman and many other economists believe that the Fed

THE ECONOMIST, AUGUST 10, 1996

Have monetary policymakers got [inflation] licked?Central bankers will tell you that they have not, and

not just out of modesty. Although plenty of them havetargets for inflation, none is sure precisely how, or howrapidly, changes in monetary policy affect the economy.So they cannot be certain that a sensible-looking interest-rate cut will not revive inflation—or that a cautious-looking rise will not tip the economy into recession.

Hence the search for . . . a simple rule for choosing [a] monetary policy that keeps inflation down without hitting the economy too hard.

3

should increase the money supply at a smooth, given percenteach year. They argue that when the amount of money in circula-tion expands too rapidly, people spend more. If the economy isoperating below capacity, this extra demand will lead to a rise in output. To produce more, businesses will have to hire moreworkers, and unemployment will decrease. If there is already fullemployment, however, the increased aggregate demand will leadto a rise in prices—inflation.

Government PolicyAccording to Monetarists

Friedman and his monetarist followers believe the economy isso complex and so little understood that government does moreharm than good in trying to second-guess businesspeople andconsumers. As a result, monetarists generallyoppose using fiscal policy to stimulate or slowthe economy.

For example, they do not believe the govern-ment should operate with budget deficits eachyear in an attempt to stimulate the economy.Instead, monetarists believe that the governmentshould balance the federal budget. This actionwould keep government from competing withprivate business to borrow money in the creditmarket. It would also reduce the amount of inter-est that the government must pay each year.

The Fed, according to monetarists, shouldalso stop trying to smooth the ups and downsin the economy. Rather, the Fed should follow amonetary rule, or allow the money supply togrow smoothly and consistently at a rate of per-haps 3 to 5 percent per year. Monetaristsbelieve that a steady growth in the money sup-ply within strict guidelines (or targets, as theyare called) is the best way to provide businesses and consumerswith more certainty about the future. According to monetarism,this policy would result in a controlled expansion of the economywithout rapid inflation or high unemployment.

Monetarist Theory and the Federal Reserve Monetaristtheory had a major influence on Federal Reserve policies in the1980s. You can trace the changing monetary policies of the Fedin Figure 17.6 on page 464.

Job Description■ Assist families

dealing withunemployment,illness, or seri-ous conflicts

■ Refer clients tospecialists

Qualifications■ Bachelor’s

degree insocial work

■ State licensingcertification

CAREERSSocial Worker

—Occupational Outlook Handbook, 2000–01

Median Salary: $30,590

Job Outlook: Above average


monetary rule: monetarists’belief that the Fed should allowthe money supply to grow at asmooth, consistent rate per yearand not use monetary policy tostimulate or slow the economy

CHAPTER 17

Monetarists’ Criticismof Fiscal Policy

Monetarists believe that the theory of fiscal policy nevermatches the reality of fiscal policy. Two reasons account for thisdiscrepancy. The first reason concerns the political process of fis-cal policy. Monetarists point out that no single government body

Changing Fed Policies To monetarists, the reduction in the amount of money in cir-culation can mean only one thing—a reduction in aggregate demand. With less aggregatedemand, fewer workers are needed and unemployment increases. What happened to theunemployment rate when Fed policies began to lower inflation from 1980–1982?


464

Sources: Economic Report of the President, 1999; Bureau of Economic Analysis

1970 1980 1990 2000

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Changing Monetary Policies of the Fed

Fed concentrates on interestrates rather than on themoney supply. In 1979, withinflation high, policy shifts.

Fed continues with a so-calledtactical monetary policy,allowing the rate of growthof the money supply to changedepending on other factors inthe economy. The federal fundsrate is targeted as a way toincrease or decrease the rateof growth of the money supply.Inflation slows dramatically bythe end of the century.

Monetarist policy begins. Fed keeps rate of growth ofmoney supply within targetsand ignores interest rates.Inflation drops, but unem-ployment increases. In 1983,policy changes again.Strict monetarism ends.

Inflation

Unemployment

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ym

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time lags: periods between thetime fiscal policy is enacted andthe time it becomes effective

designs and implements fiscal policy. The President, with the aidof the director of the Office of Management and Budget (OMB),the secretary of the Treasury, and the Council of EconomicAdvisers, designs yet only recommends the desired mix of taxesand government expenditures.

Congress, with the aid of many committees (the House Waysand Means Committee, the Senate Finance Committee, and theSenate Budget Committee, to name a few), actually enacts fiscalpolicy. One built-in organizational problem is that the power toenact fiscal policy does not rest with a single government institu-tion. Disagreement as to the proper fiscal policy emerges amongmembers of Congress and between Congress and the President.Furthermore, being politicians, they have incentives to takeactions that will look good today and help them get reelected, butwhich may hurt the economy in the long run.

Monetarists also point out that even if fiscal policy could beenacted when the President wanted, there are various time lagsbetween when it is enacted and when it becomes effective. Ittakes many months, if not years, for fiscal policy stimuli to causeemployment to rise in the economy. Consequently, a fiscal policydesigned to combat a recession might not produce results untilthe economy is already experiencing inflation. In this event, thefiscal policy could worsen the situation.

Understanding Key Terms1. Define monetarism, monetarists, monetary

rule, time lags.

Reviewing Objectives2. Graphic Organizer Create a diagram like the

one below to analyze what monetarists think thegovernment and the Fed should do to stabilizethe economy.

3. Why do monetarists criticize fiscal policy?

Applying Economic Concepts4. Monetarism Do you agree or disagree with

the theory of monetarism? Explain yourresponse.

StableEconomy

5. Making Comparisons Describe in yourown words the difference between mone-tarism and monetary policy. Share yourdescription with a classmate, making sure he or she understands the difference.




3

■ Won Nobel Prize forEconomics in 1976

■ Leading supporterof monetarism

■ Publications includeThe MonetaryHistory of the U.S.1867–1960 withAnna J. Schwartz(1963), Capitalismand Freedom (1962),and Free to Choosewith Rose Friedman(1980)

Milton Friedman has writtenextensively on the mone-

tary history of the United States.Here, Friedman explains why hedoes not approve of the Fed andgives a possible alternative solu-tion to regulating the moneysupply:

“The establishment of theFederal Reserve System . . . estab-lished a separate official bodycharged with explicit responsibilityfor monetary conditions, and sup-posedly clothed with adequatepower to achieve monetary stabil-ity or, at least, to prevent pro-nounced instability. It is thereforeinstructive to compare experienceas a whole before and after itsestablishment—say, from just afterthe Civil War to 1914 and from1914 to date.

. . . The stock of money, prices,and output was decidedly moreunstable after the establishment ofthe Reserve System than before. . . .

. . . Any system which gives somuch power and so much discretion

to a few men that mistakes—excusable or not—can have suchfar-reaching effects is a bad system.It is a bad system to believers infreedom just because it gives a fewmen such power without any effec-tive check by the body politic—thisis the key political argumentagainst an ‘independent’ centralbank.

. . . My choice at the momentwould be . . . instructing the mone-tary authority to achieve a speci-fied rate of growth in the stock ofmoney. . . . I would specify that theReserve System shall see to it thatthe total stock of money so definedrises . . . at an annual rate of Xpercent, where X is a numberbetween 3 and 5.”Checking for Understanding

1. What is Friedman’s argument againstan “independent” central bank?

2. What rule does Friedman propose togovern decisions of the FederalReserve System?

Milton FriedmanECONOMIST (1912—)

466


C H A P T E R 17

Unemployment and Inflation

• Two of the biggest threats to the nation’s economicstability are high unemployment and inflation.

• Maintaining a low unemployment rate is a goal ofstabilization policies.

• The four types of unemployment are cyclical, struc-tural, seasonal, and frictional.

• According to the theory of demand-pull inflation,prices rise because excessive business and con-sumer demand increases faster than total supply.

• The theory of cost-push inflation states that thewage demands of labor unions and the excessiveprofit motive of large corporations push up prices.

The Fiscal PolicyApproach to Stabilization

• Some economists believe economic stabilizationcan be met with fiscal policy—the federal govern-ment’s deliberate use of taxation and spending toaffect overall business activity.

• John Maynard Keynes developed fiscal policy theo-ries during the Great Depression.

• Keynesian theory states that leakages out of andinjections into the circular flow of income affectaggregate demand, and should be counteracted bygovernment taxing and spending policies.

• To bring down unemployment, Keynesian econo-mists believe in forming government-sponsoredjobs programs and cutting federal taxes.

Monetarism and the Economy

• Monetarists believe in using the growth rate of the money supply to stabilize the economy.

• The theory of monetarism is often linked witheconomist Milton Friedman.

• Friedman and his supporters believe that the Fedshould follow a monetary rule by increasing themoney supply at a smooth, given percent per year.

• Monetarists criticize fiscal policy because of thepolitical arena in which it is developed, and becausetime lags between enactment and implementationof fiscal policies may worsen the situation.

Chapter Overview Visit the Economics Today and Tomorrow Web site at tx.ett.glencoe.comand click on Chapter 17—Chapter Overviewsto review chapter information.

SECTION 1

SECTION 2

SECTION 3

http://www.glencoe.com/sec/socialstudies/economics/econtt2003/tx/chapter17/overview.shtml

Identifying Key TermsWrite a one-sentence explanation of each of thefollowing terms.

1. unemployment rate2. full employment3. underground economy4. demand-pull inflation5. stagflation6. cost-push inflation7. fiscal policy8. monetarism9. monetary rule

10. time lags

Recalling Facts and IdeasSection 1

1. What are the four types of unemployment?2. What causes demand-pull inflation?3. What causes cost-push inflation?

Section 24. What are the leakages out of the circular

flow of income?

5. What are the injections of income into thecircular flow of income?

6. What do Keynesian economists think thefederal government should do to reduceunemployment?

Section 37. Who is the economist most often linked to

monetarism?8. What do monetarists believe the Fed

should do in terms of monetary policy?

Thinking Critically1. Making Generalizations Analyze why full

employment cannot be defined as zerounemployment.

2. Understanding Cause and Effect Create adiagram like the one below to explain whythe unemployment rate might rise if fiscalpolicy were used to combat inflation.

TechnologyActivityUsing the Internet Choose a contemporaryeconomic issue such as unemployment orinflation to investigate. Using a searchengine, type in unemployment or inflation tolocate current statistics on your chosentopic. Visit a government Web site to learnabout the most up-to-date statistics. Write aone-page summary of your findings.

17

Self-Check Quiz Visit the Economics Today and Tomorrow Web site at tx.ett.glencoe.comand click on Chapter 17—Self-Check Quizzesto prepare for the Chapter Test.

468 CHAPTER 17

http://www.glencoe.com/qe/qe59.php?qi=1558&ch=17


ApplyingEconomic ConceptsUnanticipated Versus Anticipated InflationUnanticipated inflation may affect you inmany ways. For example, when inflation ishigh, banks charge higher interest rates tocompensate for inflation. If you borrowedmoney at the high interest rates and then therate of inflation fell, you would be worse off.You would be paying too much interest onthat borrowed money. Make a list of otherproblems that you might encounter if therewere a change in the rate of inflation that youdid not anticipate.

Reviewing SkillsSummarizing Information Read the excerptbelow, then answer the questions that follow.

“In recent years—as the second-longesteconomic expansion on record has spread itsimpact—most of the country has experienced ashortage of workers.

What’s most perplexing is this: Tight labormarkets are not affecting the economy the waytextbooks say they should.

Normally, in the organic life of an economy,tight labor leads to higher wages, which triggersinflation, which leads to higher interest rates,which cause the economy to slow, which theneases the demand for labor.

For years now, economists have expected thischain of events to play out. But the scenario hasbeen nipped from the start. Tight labor has notled to spiraling wages.”—The Columbus Dispatch, August 23, 1999

1. According to the article, what should hap-pen when there is a shortage of workers?

2. Summarize what the article states aboutthe economy.

CooperativeLearning Project

Organize into four groups. The first threegroups will each track one of the following:government fiscal policies, monetary policies,and major economic indicators. The lastgroup will create visuals from the informa-tion that is collected.

Using the front page of 10 consecutiveissues of the Wall Street Journal, three groupswill record a summary of news in each of theircategories. Fiscal policy includes taxes and gov-ernment spending. Monetary policy includescentral bank interest rates, money supply,open-market operations, and reserve require-ments. Economic indicators include suchmeasurements as the consumer price index,industrial production, producer prices, retailsales, stocks and bonds, and unemployment.Each item should include the category, the dateof the news, and a brief summary of the news.

As the information is being gathered bythe first three groups, the last group shouldbegin creating headlines that place the eventsin chronological order on a bulletin board. Toconclude this project, the class should dis-cuss the state of the economy as reflected inthe headlines.

Scan the international section of a news-paper or business magazine. Keep track ofthe number of times that you read about thetopics of unemployment and inflation inother countries. Create a table listing thespecific countries and the specific topics.After each entry, indicate whether the eco-nomic news was positive or negative.

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