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Five Debates Over Macroeconomic Policy- Chapter 17.docx

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Carl Denis

Five Debates Over Macroeconomic  Policy 1. Should Monetary and Fiscal policy makers try and stabilize the  economy? Yes • Economies tend to fluctuate when left on their own • Households may decide to cut back on saving, reducing aggregate demand causing supply to adjust by laying off workers resulting in lower output and GDP • This recession represents a waste of resources and policy makers should boost government spending, cut taxes and expand money supply. • When aggregate demand is excessive, risking higher inflation, policymakers should cut spending, raise taxes and lower money supply No • Monetary and fiscal policy take time as changing interest rates affects spending, however households and firms have planned their spending and thus takes time for them to adjust to new spending happens/ alter aggregate demand • Fiscal Policy takes time as the process to adjust spending policies is extensive and requires a bill to go through Cabinet committees and pass through the House of Commons and The Senate • SO then, considering the lags, policymakers should look ahead and predict future economic conditions, but this is easier said than done as economic conditions are unpredictable and constantly changing • Policymakers should refrain from intervening and be happy if they do no harm 2. Should Monetary Policy be made by an independent central bank?  Yes • Allowing elected officials to influence monetary policy causes two problems: first of which is that politicians may be tempted to use monetary policy to affect the outcome of elections through expansion of monetary policy before an election since monetary policy largely affects aggregate demand, knowing full well that inflation and unemployment will be a consequence. The second problem is that the influence of elected officials may lead to higher then desired inflation as a result of elected officials acting in a time inconsistently manor in order to curry votes (favoring lower unemployment) and thus causing the public to expect higher inflation , and the sacrifice ratio is larger • The governor of the Bank of Canada is not elected and thus faces no pressure to exploit the trade off between unemployment and inflation, meaning people are more likely to believe his announcements and therefore in the long run, there is a lower rate of inflation No • The advantage to allowing elected officials to influence monetary policy is the element of accountability. Government provides strict guidelines to bank of Canada on how to do their job, and without these guidelines the sole authority lies on the Bank, resulting in undisciplined direction with no one to hold accountable for mistakes. In a small open economy, Monetary policy has a strong impact on aggregate demand which translate into impact on employment and income, which means it is important someone be held accountable for monetary policy choices • Sacrifice ratio was larger when Bank of Canada attempt at disinflation • Finally, if people understand that reductions in unemployment are only temporary, it is unlikely that policy makers can benefit from manipulating monetary polic 3. Should the Central Bank aim for 0 inflation? Yes • Inflation confers no benefit but imposes several costs ( shoeleather costs, menu costs, misallocation of resources, increased variability of relative prices, unintended changes in tax liabilities, confusion and redistribution of wealth) • Inflation (even moderate) can be one of a nation’s largest issues • Temporary costs for permanent benfits • Costs are over exaggerated by some economists ( credibility is key, i.e price stability as a priority legislation) and inflation can be lowered at a reduced cost • 0 inflation is a more natural focal point (stability with no inflation costs) No • Price stability is desirable but the margin between moderate inflation benefits and zero inflation benefits is small • Reducing inflation by o
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