Linking Macroeconomics and Government Policy

By Sean Masaki Flynn

Part of Economics For Dummies Cheat Sheet

Macroeconomics studies national economies, concentrating on economic growth and how to prevent and ameliorate recessions. Governments fight recessions and encourage growth using monetary policy and fiscal policy.

Economists use gross domestic product (GDP) to keep track of how an economy is doing. GDP measures the value of all final goods and services produced in an economy in a given period of time, usually a quarter or a year. A recession occurs when the overall level of economic activity in an economy is decreasing, and an expansion occurs when the overall level is increasing. The unemployment rate, which measures what fraction of the labor force consists of those without jobs who are actively seeking jobs, normally rises during recessions and falls during expansions.

Anti-recessionary economic policies come in two flavors:

  • Expansionary monetary policy: The government can increase the money supply to lower interest rates. Lower interest rates make loans for cars, homes, and investment goods cheaper, which means increased consumption spending by households and increased investment spending by businesses.

  • Expansionary fiscal policy: Increasing government purchases of goods and services or decreasing taxes can stimulate the economy. Increasing purchases increases economic activity directly, giving businesses money to hire new workers or pay for increased orders from their suppliers. Decreasing taxes increases economic activity indirectly by leaving households with more after-tax dollars to spend.