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ECO209Y1 (26)

Chapter 14-Stabilization Policy

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Gustavo Indart

Chapter 14 Stabilization Policy 1) Active or Passive? Adv. Active: - recessions cause econ. Hardship - J4,O8413 *4;9,34157424901:OO025 5743 - ADAS show how fiscal and monetary policy respond to shocks and stabilize econ. Disadv. Active: - Lags hinder effectivenessimpact of policy: o Inside time between shock and policy response o Outside time takes policy to affect economy L1.43L9L438.K,3J0-0147054OL.8L25,.910O954OL.2,$%,,=0.43 Automatic Stabilizers policies that stimulatedepress economy when necessary without any deliberate policy change - designed to reduce lags - e.g. income tax (in recessions avrg. Income falls, taxperson falls), unemployment insurance (in recession unemployment rises, income falls, spending falls, AD falls unemployment insurance reduces fall and drop of AD), welfare (similar to unemployment insurance) Forecasting (predictions): 1. Leading econ. Indicators data that fluctuate in advance of econ. 2. Macroeconometric models large-scale models w estimated parameters; used to forecast response of endogenous variables to shocks and policies Lucas Critique using models estimated with historical data as predictions would not be valid if policy change alters expectations in way that changes fundamental relationships between variables - e.g. Prediction: increase in money growth rate = reduce unemployment o CRITIQUE: increasing money growth may raise expected inflation unemployment may not fall 2) Rules or Discretion? Rule set policy in advance - Adv.: o Dis97:894154OL.2,N078,354OL9L.,O574.088
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