Public Economics

Lecture 9: Stabilization function of

the state

winter semester
2014/2015

Definition
Stabilization function is a policy implementation through the
national economic policy, designed for pure state
intervention in the economy.
Contains a hierarchy of objectives and the choice of some
instruments in order to achieve those objectives.
Based on macroeconomic theory and the theory of public
choice.
Combined effect of individual actions can have unintended
consequences and lead to worse or better macroeconomic
outcomes => greater scope for government policy
intervention in macroeconomics vs. Other functions

The business cycle and policy

makers
Business cycle is the alteration between economic
downturns known as recessions and economic upturns known as recovery or expansion. (business
cycle graph)
No single view: (keynes, hayek& Mises)

Recessions are periods of economic downturns

when output expressed as GDP and employment
are falling.
Recovery (expansion) are period of economic
upturns when output employment are raising

What happens during business cycle?

Business cycle and unemployment

Shadow areas are periods of downturns they mainly coincide with

high rate of unemployment (USA 1948-2004)

What happens during business

cycle?
Business cycle and aggregate
outputs
Is the economys total production in final goods
and services for a given time period (numerical
measure is the GDP)
Over the business cycle the economys level of
output and unemployment move in opposite
direction.
Over the business cycle unemployment and
inflation (inflationary pressures) move also in
opposite way. (just mention the Phillips curve)

Kind of policy stabilization

The policy efforts undertaken to
reduce the severity of recessions and
to rein an excessively strong
expansion are called stabilization
policy.
Based on two main policies:
Monetary policy
Fiscal policy
+ international trade policy

Monetary policy central banks

Tools

Direct

Immediate
objectives

Quantity
of money

Final
objectives

Product
Employement

Indirect

Interest
rate

Price
stability

Monetary policy is a type of

stabilization policy that involves changes
in the quantity of money in circulation or

Monetary policy direct and

indirect tools
Direct tools-

Regulation of investment credit

Regulation of consumption credit

Indirect tools Policy of required reserves

Open market operations
Discount bank rate

How does the monetary policy

function? example monetary
expansion

Explanation on graph (ADxAS) and

the money market.
Short run product,
employment, price level
(inflationary pressure), nominal
interest rate, real salary wage.
Long run - real product,
employment, price level,
nominal interest rate, real salary
wage.

Fiscal policy- the government

Tools
(Tax, G)

Discretionary
policy

Immediate
objectives

Final
objectives

AD
Product
Employement

Automatic
stabilizers

AS

Price
stability

Fiscal policy is the second type of

stabilization policy that involves changes
in taxation or in government spending or

Fiscal policy- discretionary and

automatic stabilizers
Discretionary policy tools Changes in tax rate
Changes in the structure of the state budget
Changes in the amount of the state budget

Automatic stabilizers
Progressive income tax
Unemployment insurance
Subvention for certain goods or services

How does the fiscal policy

function? example fiscal
expansion

Explanation on graph (ADxAS) and the

money market.
Short run product, employment,
price level (inflationary pressure),
nominal interest rate, real salary
wage.
Long run - real product, employment,
price level, nominal interest rate,
real salary wage.
unchanged, rise, fall

Nothing changes only the

price level rises, what is the
solution?
Macroeconomic mix-

Combination of restrictive MP and FP

Combination of restrictive MP (inflation)
and expansive FP (output and
employment)
Combination of expansive MP(output,
employment) and restrictive FP
(inflation).
Expansive MP and FP.

Time and countries

macroeconomic comparability
Magic triangle- connecting four
macroeconomic components:
Economic growth (annual growth in one year
in %)
Unemployement (annual growth in %)
Price stability (annual inflation in %)
Balance of payment (measured in % it can be
positive negative or null)

More we are far from the center more our

macroeconomic situation is stable.

Exam information
1. Students interested by writing exam before
Christmas have to write clearly their name in a list I
will give you.
2. They have to be informed that if they would like to
write the final exam in 17th December they should
have the final assignment from seminar and
possibility will be given for that.
3. Otherwise, you have more possibilities for writing
exam in the first week after Christmas and further,
so go to exam when youre well prepared.
4. Next week first review sance just send your
question by mail in order to organize our review.

Thank you for your attention