Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
13e Chapter 18: Theory versus Reality McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Theory versus Reality • Theory is supposed to explain the business cycle and how to control it. • Many realities keep us from reaching our economic goals: – Conflicting advice comes from Keynesians, monetarists, and supply-siders. – Politics takes preference over economics in Congress and the presidency. – A massive, unresponsive bureaucracy exists. 18-2 Learning Objectives • 18-01. Know what the tools of macro policy are. • 18-02. Know how the macro tools should work. • 18-03. Know the constraints on policy effectiveness. 18-3 Available Policy Tools • Fiscal policy: – Tax cuts and increases. – Changes in government spending. • Monetary policy: – Open market operations. – Changes in reserve requirements. – Changes in discount rates. • Supply-side policy: – Tax incentives for saving and investment. – Deregulation. – Human capital investment. – Infrastructure development. – Free trade. – Immigration. 18-4 Fiscal Policy • Changes due to automatic stabilizers are a basic countercyclical feature of the economy. • Discretionary policy expands (or shrinks) the structural deficit and gives the economy a shot of fiscal stimulus (or restraint). – They are a result of deliberate policy decisions made by the president and Congress. 18-5 Monetary Policy • The Fed’s Board of Governors makes monetary policy, with its Open Market Committee pulling the levers. – Keynesians believe that interest rates are the critical policy lever to shift aggregate demand. – Monetarists believe that the money supply is the critical policy tool and that it should be expanded at a steady, predictable rate to ensure price stability at the natural rate of unemployment. 18-6 Supply-Side Policy • The focus of supply-side policy is to provide incentives to work, save, and invest. – Marginal tax rates and government regulations must be reduced to get more output without inflation. • Since the supply-side policy levers require changes in laws and regulations, the Congress and the president enact supply-side policy. – Fiscal and supply-side policies often get entwined. 18-7 Idealized Uses: Recession • Goal: to close the recessionary GDP gap. – Keynesians want to increase AD by tax cuts or spending increases. Also, they want falling interest rates to spur investment. – Monetarists see no use in fiscal policy. • Their appropriate response is patience. – Supply-siders would cut tax rates and reduce regulation. Any spending increase should focus on long-run development. 18-8 Idealized Uses: Inflation • Goal: to close the inflationary GDP gap. – Keynesians would decrease AD by raising taxes and cutting government spending. – Monetarists would reduce the money supply. – Supply-siders would look for ways to expand productive capacity. • It is both “too much money” and “not enough goods.” • They propose incentives to save and not spend. • They would cut taxes and regulations that raise production costs. 18-9 Idealized Uses: Stagflation • Both inflation and unemployment are high, and economic growth is stagnant. – Fiscal restraint and tight money will reduce inflation but increase unemployment. – Fiscal stimulus and easy money will reduce unemployment but increase inflation. – If stagflation is caused by adverse policy (high taxes, excessive regulation), supply-siders propose reversing those policies. – If stagflation is caused by external forces (oil price spike, natural disaster), no policy can help much. 18-10 Fine-Tuning • Fine-tuning: policy adjustments designed to counteract small changes in economic outcomes. • In 1946 Congress committed the government to macro stability. – In 1978 Congress set goals of 4% unemployment, 3% inflation, and 4% economic growth. – The reality is that government has difficulty making fine-tuning adjustments to meet these conflicting goals. 18-11 Goal Conflicts • The trade-off between unemployment and inflation is a fiscal policy goal conflict. • The Fed wants fiscal stability, while the president and Congress may be unwilling to raise taxes or cut spending. • Some cutbacks affect the neediest and become politically impossible to enact. • All decisions have an opportunity cost, raising conflict between the benefits and the cost of a policy option. 18-12 Measurement Problems • Measuring the macro variables takes time, so the results are not available for a month or so. • Policymakers rely on economic forecasts made by “experts” using models that are tied to one theory or another. • Some data (called leading indicators) tend to predict turns in the business cycle. • External shocks are not predictable. 18-13 Design Problems • Once we think we know what the problem is, we must design a “fix” for the problem. • Should we take – The Keynesian approach? – The monetarist approach? – The supply-sider approach? • How will the marketplace respond to our plan? 18-14 Implementation Problems • Any “fix” must work through congressional deliberations and be approved by the president. • Once approved, there is no assurance it will be put into effect in a timely manner. – The time lag may be so great that a stimulus package may go into effect after a recession has ended. • Political pressure may preclude a correct “fix” from ever being passed. 18-15