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ECON1000 CH. 17.docx

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Carleton University
ECON 1000
Nick Rowe

Chapter 17: Five Debates over Macroeconomic Policy Should Monetary and Fiscal Policymakers try to Stabalize the Economy? Pro: Policymakers should try to stabilize the economy • The economy is inherently unstable, and left on its own will fluctuate o Policy can manage aggregate demand to offset this inherent instability and reduce the severity of economic fluctuations • Society should not have to suffer through the booms and busts of the business cycle • Monetary and fiscal policy can stabalize aggregate demand and tehreby, production and employment Con: Policymakers should not try to stabilize the economy • Monetary policy affects the economy with long and unpredictable lags between the need to act and the time that it takes for these policies to work o Many studies indicate that changes in monetary policy have little effect on aggregate demand until about six mnonths after the change is made • Fiscal policy works with a lag because of the long political process that governs changes in spending and taxes • It can take years to propose, pass and implement a major change in fiscal policy • All too often policymakers can inadvertently exacerbate rather than mitigate the magnitude of economic fluctuations • It might be desireable if policy makers could eliminate all economic fluctuations; but this is not a realistic goal Should you be more likely to support active stabilization of policy if wages, prices and expectations adjust quickly in response to economic changes, or if they adjust slowly? • If wages, prices and expectations adjust slowly, it will take longer for the economy to return to its natural rates of output and unemployment. • In that case, there is a better chance that expansionary policy wil act in time to alleviate the recession, rather than push the economy into an inflationary boom. Should monetary policy be made by an Independent Central Bank? Pro: Monetary Policy should be made by an independent central bank • Allowing elected officials influence in conductiong monetary policy has two problems: o Politicians are sometimes tempted to use monetary policy to affect the outcome of elections o To the extent that central bankers allu themselves with politicans, discretionary policy can lead to economic fluctuations that reflect the electoral calender--the political business cycle • Such influence might lead to more inflation than desireable: o There may be discrepency between what policymakers say they will do and what they actualy do--called inconsistency of policy o Policymakers are so often time inconsistent, people are skeptical when central bankers announce their intentions to reduce the rate of inflation • One way to avoid these difficulties is to conduct monetary policy independent of political influence • Comparisons of average rates of inflations across countries show that those countries with the most independent central banks tend to have the lowest rate of inflation Con: Monetary Policy should not be made by an independent central bank • An important advantage of elected officials having a say in conducting monetary policy is accountability • The practical importance of time inconsistency is far from clear • The supposedly enhanced credibility of monetary policy announcements that come from central bank independence seems to yield few dividends • The idea that elected policymakers might use monetary policy to generate political business cycles seems at odds with the concept of rational expectations Should the central bank aim for zero inflation? Pro: The central bank should aim for zero inflation • Inflation confers no benefit to society, but it imposes several real costs o Shoeleather costs o Menu costs o Increased variability of relative prices o Unintended changes in tax liabilities o Confusion and inconvenience o Arbitrary redistribution of wealth • Reducing inflation is a policy with temporary costs and permanent benefits • Zero provides a more natural focal point for policymakers than any other number Con: The central bank should not aim for zero inflation • Zero inflaion is probably unattainable and to get there involves output, unemployment and social costs that are too high • Policymakers can reduce many of the costs of inflation without actually reducing inflation Should fiscal policymakers reduce the government debt? Pro: Policymakers should r
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