The days of laissez-faire when there was a good deal of bias against all forms of state interference have gone. In fact, it may be doubted whether there was ever any state that did not exercise any degree of control over the economic activities of a community.
Such control was reduced to the minimum during the middle of the nineteenth century under the impact of the individualistic theory.
But before the nineteenth century was over, there was a reaction against the theory of individualism followed by the decline of laissez-faire.
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This creeping trend towards state intervention in economic affairs was aided by the upheaval caused by the First World War The exigencies of a world war forced the state to exercise large powers of control over economic life in order to harness all resources to the task of winning the war.
The colossal unemployment which prevailed in every country after the onset of the Great Depression of the thirties forced the state to step in to relieve the misery of the unemployed. It slowly came to be recognised that the achievement and maintenance of full employment ought to be the fundamental aim of state policy.
Mere monetary measures might not enable a country either to achieve or to maintain full employment. The factors at work in causing lapses from full employment are often non-monetary and these cannot always be controlled by monetary weapons.
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The volume of investment may not be sensitive to changes in the rate of interest. The long-term rate of interest declined to a considerable extent during the years 1932-41, but it was not followed by high level of investment activity. Moreover, the central bank is not always free to change the rates of interest in either direction.
A country will not suffer from acute unemployment as long as the volume of expenditure on goods and services is maintained at a high level.
The existence of mass unemployment in a free enterprise economy shows that private expenditure cannot be expected to reach a level sufficient to provide employment for all workers.
Hence it becomes incumbent on the government to supplement private expenditure by the amount that will enable the country to achieve full employment.
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Fiscal policy refers to the policy in connection with (a) Government Spending, (b) Taxation and (c) Borrowing. The total volume of expenditure in the community can be increased by the right type of fiscal policy.
Though the fiscal techniques were discovered and first made use of during the depression of the thirties, the techniques are capable of being applied equally effectively in times of inflation.
It can be raised to a higher level by an appropriate fiscal policy. The result will be a shift of E towards E17 the full employment equilibrium position.