What is Stabilization Policy?

Stabilization policy is a macroeconomic strategy enacted by governments and central banks to maintain healthy levels of economic growth and minimize price changes. Sustaining a stabilization policy requires monitoring the business cycle and adjusting benchmark interest rates to control aggregate demand in the economy. The policy seeks to limit any erratic swings in total output, as measured by gross domestic product (GDP), as well as controlling surges in inflation or deflation. Stabilization of these factors generally leads to healthy levels of employment as well.

Stabilization policy seeks to avoid erratic economic swings and control surges.

As well as their customary use, stabilization policies may be deployed to help an economy recover from an economic crisis or shock, such as a sovereign debt default or a stock market crash. In these instances, policy may come directly from governments through overt legislation and securities reforms, or be mandated by international banking organizations such as the World Bank.

The Roots of Stabilization Policy

Pioneering economist John Maynard Keynes theorized that when individuals within an economy do not have the buying power to purchase the goods or services being produced, prices fall as a means to entice customers. As prices fall, businesses can experience significant losses, resulting in an increase in corporate bankruptcies. In turn, unemployment rates increase, which further reduces the buying power in the consumer market. This loss of buying power thus lowers prices again.

Keynes considered this process to be cyclical in nature. To stop the cycle, he asserted, requires changes in fiscal policy, such as the manipulation of aggregate demand. Under Keynesian theory, demand is stimulated to counter high levels of unemployment and suppressed to counter rising inflation.

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.

The Future of Stabilization Policy

Top economists believe that maintaining a steady price level and pace of growth are essential for long-term prosperity, not least as economies become more complex and advanced. Any of those variables becoming too volatile can lead to unforeseen consequences to the broad economy, and so hamper markets from functioning at an optimal level of efficiency.