conomic policymakers, following the lead of J. M. Keynes, have accepted the boom/bust cycle as an essential feature of a modern economy, and have learned how to use monetary and fiscal policy to mitigate the severity of its effects. These "Keynesian" management tools have had considerable success. Since the great depression of the 1930s, economic downturns (and their flip-side, inflationary shocks) have periodically come and gone, but they have never wrought anything close to the devastation of the Great Depression.
f an "overheating" of demand brings about too much inflation, the central bank (in the US, the Federal Reserve, or Fed) takes steps to slow down the increase in the money supply, by raising interest rates. They can also limit the amount of available credit by increasing the required amount that banks must keep in reserve. Both moves are ways to increase the cost of borrowing money. Money that is borrowed is money that is placed into circulation — if less borrowing takes place, less money is available in the economy. That will slow down the rise in prices — but it will also probably slow down demand and output as well. In fact, the Fed can cause a recession by raising interest rates (the increased cost of money becoming, in effect, a supply shock).
f output starts to cool off, the Fed can do the opposite: lower interest rates to make credit easier to get, in the hope of creating a positive supply shock.
he other main tool in the Keynesian arsenal is in the area of fiscal policy. Declining output can be pushed back up through the use of deficit spending: borrowing money for the government to use now to stimulate the economy. The hope is (at any rate) that it can be paid back later when times are good and booming output would create a generous tax base.
ince the 1980s, the "Supply Side" economic theories of Arthur Laffer and others began to influence policy. The supply-siders believed that high tax rates stifle production, and that the most effective form of economic stimulus is not "demand-side" decficit spending, but reductions in tax rates.