Question

Clearly and briefly articulate and explain in your own words 1 argument used against an active stabilization policy.

Answer 1

Active stabilization policy refers to the use of Aggregate Demand tools to stabilize the output, inflation and employment. One argument against active stabilization policy is that these offsetting effect of these policies may not be effective due to long lags. Since these policies can take months to offset the negative effect of an external shock, it is possible that they might do more harm in the event the economic conditions change.

For e.g. The central may cut the interest rates in response to a recession marked by a decrease in output. However, it may take 3 months before the positive effects can be felt. Having said that, the economy may revive on its own by then. The lower interest rate may then result in inflation due to excess demand in the economy.