Introduction to Finance

gross domestic product (GDP) 
measures the output of goods and 
services in an economy

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5.2 Four Policy Maker Groups
105
Price Stability
In recent decades, the importance of stable prices has become well accepted but diffi
cult to 
achieve. Consistently stable prices help create an environment in which the other economic 
goals are more easily reached. 
Infl ation
, which we initially defi ned in Chapter 2, occurs when 
a rise or increase in the prices of goods and services is not off set by increases in the quality of 
those goods and services. Infl ation discourages investment by increasing the uncertainty about 
future returns. Therefore, high infl ation rates are no longer considered acceptable as a price to 
pay for high levels of employment.
Infl ation was at double-digit levels during the early 1980s, and this was refl ected in 
record-high interest rates. However, as the economy turned down in the 1981–1982 recession, 
infl ation rates also started down and continued down until infl ation fell below 3 percent. After 
a brief rise at the beginning of the 1990s, infl ation steadily declined to 2 percent and continued 
at very low levels in the early years of the twenty-fi rst century. The Fed began increasing its 
federal funds rate target in 2004 because of concern about possible increasing infl ation. After 
the housing bubble collapse in mid-2006, the Fed began lowering its federal funds rate target. 
Then, in response to the fi nancial crisis and the start of the Great Recession, the Fed reduced 
its target for the federal funds rate to a near zero level beginning in late 2008. However, infl a-
tion rates remained below the 2 percent level through early 2016. 
Domestic and International Implications
The three national economic policy objectives are sometimes in confl ict with each other. For 
example, while economic growth generally leads to higher employment, a too rapid growth 
rate is likely to lead to higher infl ation. Greater demand relative to supply for workers and 
materials could cause prices to rise. On the other hand, a very slow growth rate, or even 
economic contraction will lead to higher unemployment rates and little pressure on prices. 
Thus, policy makers must attempt to balance these economic goals as they establish eco-
nomic policy.
Actions taken with respect to a country’s own national aff airs also infl uence the econo-
mies of other nations. Thus, it is important for economic policy makers to maintain a world-
view rather than just a narrow nationalistic approach. Nations that export more goods and 
services than they import have a net trade surplus, and vice versa. When funds received 
from the sale (export) of goods and services to other countries are less than the payments 
made for the purchase (import) of goods and services from other countries, these trade defi -
cits must be made up by positive net fi nancial transactions and foreign exchange operations 
with the rest of the world. We discuss balance of payments components and implications in 
Chapter 6.
5.2
Four Policy Maker Groups
Four groups of policy makers are actively involved in achieving the nation’s economic policy 
objectives:
• Federal Reserve System
• The president
• Congress
• U.S. Treasury