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Government's Role in the
Economy
While consumers and producers make most decisions that mold the economy, government activities have
a powerful effect on the U.S. economy in at least four areas.
Stabilization and Growth. Perhaps most importantly, the federal government
guides the overall pace of economic activity, attempting to maintain steady growth, high levels of employment, and
price stability. By adjusting spending and tax rates (fiscal policy) or managing the money supply and controlling
the use of credit (monetary policy), it can slow down or speed up the economy's rate of growth -- in the process,
affecting the level of prices and employment.
For many years following the Great Depression of the 1930s, recessions -- periods of
slow economic growth and high unemployment -- were viewed as the greatest of economic threats. When the danger of
recession appeared most serious, government sought to strengthen the economy by spending heavily itself or cutting
taxes so that consumers would spend more, and by fostering rapid growth in the money supply, which also encouraged
more spending. In the 1970s, major price increases, particularly for energy, created a strong fear of inflation --
increases in the overall level of prices.
As a result, government leaders came to concentrate more on controlling
inflation than on combating recession by limiting spending, resisting tax cuts, and reining in growth in the
money supply.
Ideas about the best tools for stabilizing the economy changed substantially between
the 1960s and the 1990s. In the 1960s, government had great faith in fiscal policy -- manipulation of government
revenues to influence the economy. Since spending and taxes are controlled by the president and the Congress, these
elected officials played a leading role in directing the economy. A period of high inflation, high unemployment,
and huge government deficits weakened confidence in fiscal policy as a tool for regulating the overall pace of
economic activity. Instead, monetary policy -- controlling the nation's money supply through such devices as
interest rates -- assumed growing prominence. Monetary policy is directed by the nation's central bank, known as
the Federal Reserve Board, with considerable independence from the president and the Congress..
Regulation and Control. The U.S. federal government regulates private
enterprise in numerous ways. Regulation falls into two general categories. Economic regulation seeks, either
directly or indirectly, to control prices. Traditionally, the government has sought to prevent monopolies such as
electric utilities from raising prices beyond the level that would ensure them reasonable profits. At times, the
government has extended economic control to other kinds of industries as well. In the years following the Great
Depression, it devised a complex system to stabilize prices for agricultural goods, which tend to fluctuate wildly
in response to rapidly changing supply and demand. A number of other industries -- trucking and, later, airlines --
successfully sought regulation themselves to limit what they considered harmful price-cutting.
Another form of economic regulation, antitrust law, seeks to strengthen market forces
so that direct regulation is unnecessary. The government -- and, sometimes, private parties -- have used antitrust
law to prohibit practices or mergers that would unduly limit competition.
Government also exercises control over private companies to achieve social goals,
such as protecting the public's health and safety or maintaining a clean and healthy environment. The U.S. Food and
Drug Administration bans harmful drugs, for example; the Occupational Safety and Health Administration protects
workers from hazards they may encounter in their jobs; and the Environmental Protection Agency seeks to control
water and air pollution.
American attitudes about
regulation changed substantially during the final three decades of the 20th century. Beginning in the 1970s,
policy-makers grew increasingly concerned that economic regulation protected inefficient companies at the
expense of consumers in industries such as airlines and trucking. At the same time, technological changes
spawned new competitors in some industries, such as telecommunications, that once were considered natural
monopolies. Both developments led to a succession of laws easing regulation.
While leaders of both political parties generally favored economic deregulation
during the 1970s, 1980s, and 1990s, there was less agreement concerning regulations designed to achieve social
goals. Social regulation had assumed growing importance in the years following the Depression and World War II, and
again in the 1960s and 1970s. But during the presidency of Ronald Reagan in the 1980s, the government relaxed rules
to protect workers, consumers, and the environment, arguing that regulation interfered with free enterprise,
increased the costs of doing business, and thus contributed to inflation. Still, many Americans continued to voice
concerns about specific events or trends, prompting the government to issue new regulations in some areas,
including environmental protection.
Some citizens, meanwhile, have turned to the courts when they feel their elected
officials are not addressing certain issues quickly or strongly enough. For instance, in the 1990s, individuals,
and eventually government itself, sued tobacco companies over the health risks of cigarette smoking. A large
financial settlement provided states with long-term payments to cover medical costs to treat smoking-related
illnesses.
Direct Services. Each level of government provides many direct services. The
federal government, for example, is responsible for national defense, backs research that often leads to the
development of new products, conducts space exploration, and runs numerous programs designed to help workers
develop workplace skills and find jobs. Government spending has a significant effect on local and regional
economies -- and even on the overall pace of economic activity.
State governments, meanwhile, are responsible for the construction and maintenance of
most highways. State, county, or city governments play the leading role in financing and operating public schools.
Local governments are primarily responsible for police and fire protection. Government spending in each of these
areas can also affect local and regional economies, although federal decisions generally have the greatest economic
impact.
Overall, federal, state, and local spending accounted for almost 18 percent of gross
domestic product in 1997.
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