STABLE ECONOMIC GROWTH: Can a Government Achieve Stable Economic Growth?

What is the Extent to Which a Government can Achieve Stable Economic Growth?

It goes without saying that governments desire to have stable economic growth whereby they create a stable platform for long-run economic growth to occur and reduce uncertainty which causes instability. Therefore, stability in an economy is vital for the improvement of macroeconomic performance.

A government can seek stability via several policy measures; 1) a ‘prudent’ approach to economic management. 2) Fiscal and monetary policy decisions should be used for long-term interests and should support each other also. 3) Making policies transparent and open. 4) Improving supply-side performance of an economy.

Stability, however is harder to obtain thanks to the multiplier and accelerator concepts. The multiplier effect is where an increase in levels of demand (AD) lead to a greater final increase in output (GDP). Higher levels of government spending creates further employment and increases AD, in theory. These new workers then go and spend their new income and so increase levels of consumption – which is a major component of AD – which increases levels of demand and so the cycle repeats itself. This effect means that when an economy is booming then it typically causes rapid demand-led growth. This then causes fluctuations in the economic cycle due to growth exceeding its trend rate.

Although, this effect depends on the size of the injection because if it is small then the final outcome in terms of the new levels of investment, consumption or other components of AD won’t be large enough to have an impact on AD. Moreover, the effect depends on whether or not firms have spare demand as, if AD is increasing but supply is increasing at the same rate then the economy won’t hit the ‘ceiling’ of the economic cycle. Furthermore, the multiplier effect concept doesn’t take into account the idea that external shocks to the economy may alter levels of aggregate demand – as everybody knows that these shocks are unpredictable.

The other reason that economic stability is tough to achieve is down to the accelerator concept. It states that investment is needed to replace capital stock and to provide new capital stock to meet rising levels of demand. When an economy is in a recession, there is no incentive to increase productive capacity and thus little incentive to invest. Contrarily, during times of rising demand, investment will rise as there would be more need for greater productive capacity. This increase may be larger than the increase in national income and as a result, investment becomes volatile and the uncertainty borne from it lowers AD.

However, it is important to note that the accelerator concept ignores the role of confidence in an economy. What’s more is that firms may delay investment regardless of the increases levels of demand.

A government aims to overcome these effects and flatten out the booms and recessions that these concepts cause. They can use fiscal or monetary policy instruments to achieve stability. Fiscal policies aim to reduce a budget deficit during a boom (where taxes don’t cover the levels of government spending) and the ‘fiscal cycle’ dampens a boom via automatic stabilizers. The extent to which this dampens a boom depends on whether a government spends its new surplus or tries to reduce a deficit – if it spends its surplus then it tends to crowd out the private sector and reduces potential long run economic growth due to a loss of private sector investment. Monetary policy instruments raise the interest rate to dampen accelerating inflation and vice versa with slowing inflation. The problem with inflation targeting is that the bank has to be good and reliable at forecasting inflation as if it isn’t then that creates uncertainty.

In reality, there will always be uncertainty in an economy and so it will never be easy for governments to achieve completely stable growth. However, there have been significant improvements in achieving stability and the government can claim credit for recent more stable rates of inflation.

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