Fiscal Policy to Stabilise the Economy

Abstract

Fiscal measures to counteract fluctuations in the level of economic activity associated with the trade cycles (see p. 50) have been in use for over fifty years. Governments in the 1930s accepted that they not only could, but should, adopt a fiscal policy to stabilise national economies so as to prevent the evils of unemployment and inflation from developing. In the nineteenth century, there was little discussion of the need for a government to maintain employment. The doctrine of laissez-faire prevailed and Say's law of markets, which postulated that unemployment could not occur, was widely accepted. Jean Baptist Say's theory, which he published in 1803, has been summed up by the famous phrase, ‘Supply creates its own demands’. As various producers supply goods and services to the markets where these goods and services are sold or exchanged for one another, the aggregate demand will correspond to supply. If the supply of goods and services is doubled, the aggregate demand will double. On the basis of this line of argument, there will be no overproduction, no deficiency of aggregate demand and no unemployment. Thus supply will create the means that enables the aggregate demand to absorb output. Say's view was shared by other eminent writers of the time. For instance, David Ricardo (1772–1823) wrote, in reference to a nation, ‘supply can never exceed demand’.