Download Chapter 14: Aggregate Demand Policy in Perspective

Chapter 14: Aggregate Demand Policy in Perspective
I. Supply versus Demand Policy
A. Supply-Side policies such as tax breaks or subsidies designed to expand investment
spending, including but not limited to R&D, are meant to:
1. Increase Capital Stock (amount of physical capital in the economy)
2. Shift both short-run and long-run AS curves to the right due to:
a. Overall capacity of capital is increased
b. Increased capital improves productivity of other factors
3. Are intended for long-term benefit, including a tradeoff of more future
consumption goods for fewer current consumption goods.
B. Demand side policies
1. Are meant to address overcapacity in an economy that is below potential output
2. Increase current consumption of consumer goods (increasing AD)
II. Fiscal Policy problems
A. Offsets to fiscal policy are described by the concept of: Crowding Out
B. (lack of/insufficient) knowledge of key benchmarks is problematic. Assessing levels of :
1. Potential GDP (and by implication the target employment rate)
2. MPE (mpc)
3. “The current situation” i.e. the direction and momentum of the current economic
cycle
are difficult to determine.
C. Ease with which G can increase and T can decrease (political/constituent popularity) and
the converse: the difficulty of decreasing G or increasing T
D. Economic drags from a large public debt (national debt)
E. Fiscal policy may interfere with other policy objectives
1. Monetary policy may be inhibited in its aim to minimize inflation
(some monetary authorities have inflation control as their stated #1 priority; others
have concerns that equal inflation containment in urgency – sustainable GDP growth
and low unemployment)
2. Expansionary fiscal policy may well increase imports which will be problematic if
a country is mandating exports=imports (trade deficit/surplus=0)
F. Automatic stabilizers, while they “automate” a countercyclical fiscal policy, they can be
expected to create leakages that slow down a recovery.
III. States tend to be procyclical in fiscal policies
A. Some states have balanced budget legislation or constitutional amendments
B. The political response to a windfallin tax receipts is to increase G and possibly lower
taxes (T).
Solutions to the problem of procyclical fiscal policies in states:
C. A real rainy day fund, meaning both sizable in significance to that state’s economy, and
with protections from any usage except for countercyclical relief.
D. Moving average budgets, such as on a 5-yr. term
IV. Fiscal as compared to Monetary policy
The grid 14-4 on p. 358 shows advantages versus disadvantages of the monetary versus fiscal
responses to either a recession or an expansion.
A. Monetary policy is more useful when a near-term solution is needed than fiscal policy,
largely because its implementation is direct and decisive while fiscal policy usually gets debated,
compromised, hammered out, and eventually enacted with a thoroughly politicized (politically
influenced) result.
This is not to say the Fed is devoid of politics, but the scrutiny (analysis) of every important
fiscal policy move is due to and viewed through the lens of politics, while analysis of monetary
policy is with rare exception solely economic.
It is in terms of implementation of policy that we see a stark contrast from fiscal policy.
Also basis points can be targeted precisely to 1 point (1/100th %)so there is some greater degree of
fine-tuning at work.
V. Alternatives to Fiscal of Monetary policies
A. Directed Investment Policies
1. Rosy Scenario Policy: optimistic predictions broadcast loudly and broadly
2. Financial Guarantees: Japan had to fulfill a lot of these guarantees in the 90’s; so
did the U.S. in the Savings & Loan and LTCM bailouts. Recently airlines have received significant
bailouts and, through the courts, pension relief.
B. Autonomous Consumption policies: encourage expansion of credit (or policies to rein in
use of credit).
C. Trade policies
1. Export-Led growth: policies that focus on greater sales for domestic exports.
a. Increase global interdependency by expanding and initiating new trade
agreements that seek to eliminate and/or phase out quotas and tariffs.
2. Exchange rate policies: devalue currency (through expanionary monetary policy
or printing money) or respond passively to ongoing devaluation due to global and domestic
economic forces
VI. Credibility in policies
A. The reason the Fed telegraphs its moves with public speeches to achieve the desired
rational behavior without yet making any real transaction to achieve that economic
outcome (i.e. greater or reduced Investment spending) or ultimate goal of low inflation,
for example.
B. In other words “bark” policy can work (ideally) as well as “bite” policy
C. If credibility is high, meaning it is widely thought the current policy regime (usually
articulated in announcements) will be followed in the future, basically no matter what –
undeterred by temporary shocks. “The future” here refers to the next several quarters
and probably a few years, not indefinitely.
D. Policy regime is differentiated from a “policy” which is just a one-time reaction to a
problem or temporary shock to the economy.
E. Despite the Pay-as-you-go rule in Fiscal policy and some feedback rules (like the Taylor
rule) that influence Monetary policy, both policies maintain a high degree of discretion
(choice) in their execution.