Stabilization Policy

What is a 'Stabilization Policy'

A stabilization policy is a macroeconomic strategy enacted by governments and central banks to keep economic growth stable, along with price levels and unemployment. Ongoing stabilization policy includes monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in the economy. The goal is to avoid erratic changes in total output, as measured by gross domestic product (GDP) and large changes in inflation; stabilization of these factors generally leads to moderate changes in the employment rate as well.

BREAKING DOWN 'Stabilization Policy'

Stabilization policies are fiscally oriented and designed to reduce fluctuations in certain areas of the economy, such as inflation and unemployment, while aiming to maximize associated national income levels. Fluctuations can be controlled through various mechanisms including policies designed to increase demand to help counter high levels of unemployment or to suppress demand in response to rising inflation.

Stabilization Policy and Economic Recovery

Stabilization policies are also used to help an economy recover from a specific economic crisis or shock, such as sovereign debt defaults or a stock market crash. In these instances, stabilization policies may come from governments directly through overt legislation, securities reforms or from international banking groups, such as the World Bank.

Stabilization Policy and Keynesian Economics

Noted economist John Maynard Keynes theorized that when the individuals within an economy did not have the buying power necessary to purchase the goods or services being produce that, in order to entice consumers, prices would fall. As prices fall, businesses could experience significant losses, resulting in an increase in corporate bankruptcies. As former employees of the now defunct companies joined the ranks of the unemployed, resulting in less buying power in the consumer market, prices would need to fall again.

This process was considered cyclic in nature, and in order to stop the cycle, fiscal policy changes would be required. Keynes suggested that, through policy creation, a government could manipulate aggregate demand to correct the trend.

As economies become more complex and advanced, top economists believe that maintaining a steady price level and pace of growth is the key to long-term prosperity. When any of the aforementioned variables becomes too volatile, there are unforeseen consequences and effects to the broad economy that keep markets from functioning at their optimum level of efficiency. Most modern economies employ stabilization policies, with much of the work being done by central banking authorities like the U.S. Federal Reserve Board. Stabilization policy is largely credited with the moderate but positive rates of GDP growth seen in the United States since the early 1980s.