Actions for Stabilizing an Economy - Essay Example

"The arguments for stabilization policy are considerably weakened by the rational expectations hypothesis, given that counter-cyclical aggregate demand policy is, at best, ineffective in stabilizing output at full employment."    Stabilisation Policies are courses of action that aim to stabilize an economy. Interventionist government is driven by its desire to ensure that its economy is stable or predictable to empower its country to attract more investors if not ensure that its current industries remain profitable devices or measures that stabilise the economy. The government’s interest in stabilizing the economy is not only rooted in its political responsibility to control fluctuations in prices but equally to reign in inflations that are brought about by temporary economic stressors as well. Ensuring the predictability of its economy will strengthen the job market and will also reinforce the collective confidence of the people in the government and its goals.   These controls when implemented on key economic indicators products such as oil or even wheat are effective tools in stabilizing an economy. However, the results of these controls are not absolute due to the volatile nature of the economy. While enforcing stricter rules and regulations, the government can also influence the supply or the availability of goods in the market which will, in turn, force the prices of that commodity.   The “rational expectation hypothesis” or “theory of rational expectation” posits that in uncertain conditions, the main players—composed of the people—in any economy make decisions based on their perceptions of how economic stressors will affect them (Muth, 1992). Meanwhile, an economic agent’s rational expectations revolve around other market forces that would include government intervention, raw materials, or input materials availability to create the best possible economic model for the future. Thus, the rational expectation hypothesis proposes that economic predictions based on the correlation of an infinite number of different variables are correct even if individual predictions made on the different variables turn out to be erroneous or inaccurate so long as the expected model holds. 

The primary reason why stabilization policies are enforced or applied to a volatile market is to stabilize the economy, if not make it more predictable for economic agents to settle. However, if economic agents create an economic model base on the current economic values of economic stressors towards stabilizing the economy, the introduction of a new variable from the government base on the “rational expectation hypothesis” will not make a huge impact. The primary reason for this is that over time, given that the economic agents also need to respond to the economic model they created the economy will eventually stabilize or settle.

Cyclical Aggregate Demand Policy defines an economic system’s fluctuations as far as demands for goods are concerned. Countercyclical or reversal of the economic system’s demand for goods to force it to follow a different path is not an absolute solution to stabilize prices in particular and stabilize the economy in general. This is especially accurate at full employment since the output of the workforce will eventually find its way to the mainstream market where its price is subject to market forces. The proposition that stabilization policies are negated by the rational expectation hypothesis is true. To illustrate counter-cyclical aggregate demand policies at full employment cannot be sustained in an open economy. Since full employment translate to or will lead to a fresh supply of goods pouring into the system that would circumvent the intent to reverse the cyclical aggregate demand. Limiting the supply of goods to counter any cyclical aggregate demand when there is full employment will not be successful unless the freshly produced commodities are either warehoused or their release to the open market is restricted.

However, impending war, typhoons, earthquakes, or any imminent cataclysmic event, natural or man-made, provide a more pronounced impact on stabilization policies. In this instance, the Rational Expectations of the smallest economic unit, the people, invalidate the normal parameters (Lucas, 1973).  The impact of media and the information it provides also influence the collective thinking processes of the population. The way information is presented therefore provides the starting point of the population’s thinking process. Validation of the acceptance, appreciation, and reaction of the population provides the impetus for their rational expectations.  The importance of the media’s influence over the economic dynamics of a nation has never been more pronounced in history except in the last few decades. To illustrate: an impending collapse of a bank will and can immediately lead to bank runs even if the report turns out to be false, the false report would have already cost the bank millions of losses. The same is true for publicity about a product. The impact on the product’s viability in the market can either be made or broken by good reviews or adverse reporting.
Money’s strength is based on the trust of its people in the monetary unit. An economy’s strength is rooted in the stability of its monetary system. Trust is based on perception, and perception is formed by the sum product of the information gathered from the environment. Information from the environment can be from friends or the media.

A new model therefore should be formulated to make stabilisation policies more effective. The model should include the way information is presented to form the perception and the collective opinion of the population towards a particular news report. This should however be in conjunction with the actual implementation of the stabilisation policies proposed to be implemented. Read More