In this chapter, I discuss the roles of fiscal and monetary policies in achieving full employment. These two are the main tools that governments have at hand to achieve this objective. I start with a discussion of fiscal policy and budget deficits and address the widely held belief that budget deficits cause inflation, lead to increases in interest rates, and crowd out private investment. I move in the following section to a discussion of monetary policy and the evidence of the role of interest rates in stimulating investment and averting inflation. In this chapter, I argue that governments and central banks have powerful tools to contribute to full employment. In fact, failure to understand how these tools operate in modern economies is an important reason for pervasive involuntary unemployment.

For a long time, economists have distinguished between policies for stabilization (short- and medium-term issues) and policies for growth (long-term issues). The tools to stabilize the economy (i.e., to counteract economic fluctuations) are monetary and fiscal policies that focus on aggregate demand. Some economists think that these have no impact on long-run growth (i.e., the neutrality-of-money proposition).