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PowerPoint Presentations for
Principles of Macroeconomics
Sixth Canadian Edition
by Mankiw/Kneebone/McKenzie
Adapted for the
Sixth Canadian Edition by
Marc Prud’homme
University of Ottawa
FIVE DEBATES OVER
MACROECONOMIC
POLICY
Chapter 17
Copyright © 2014 by Nelson Education Ltd.
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SHOULD MONETARY AND FISCAL POLICY
MAKERS TRY TO STABILIZE THE ECONOMY?
Even if policy makers can influence shortrun
economic fluctuations, does that mean they
should?
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Pro: Policy Makers Should
Try to Stabilize the Economy
 While few would suggest that policy makers
should respond to every minor rise and fall in the
economy, there is no reason for society to suffer
through the large booms and busts of the
business cycle.
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Con: Policy Makers Should Not
Try to Stabilize the Economy
 Although monetary and fiscal policy can be used
to stabilize the economy in theory, there are
substantial obstacles to the use of such policies in
practice.
 One problem is that monetary and fiscal policy do
not affect the economy immediately but instead
work with a long lag.
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QuickQuiz
Explain why monetary and fiscal policy
work with a lag.
Why do these lags matter in the choice
between active and passive policy?
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SHOULD MONETARY POLICY BE MADE
BY AN INDEPENDENT CENTRAL BANK?
 Some economists are critical of the Bank of
Canada’s independence.
 The second debate over macroeconomic policy
focuses on whether the bank should be allowed
to conduct monetary policy without being
directly answerable to the electorate or to
elected officials.
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Pro: Monetary Policy Should Be Made
By an Independent Central Bank
 Allowing elected officials to have influence in
conducting monetary policy has two problems:
 When given this power, politicians are sometimes
tempted to use monetary policy to affect the
outcome of elections.
 Allowing elected officials a say in conducting
monetary policy might lead to more inflation than is
desirable.
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Con: Monetary Policy Should Not Be Made
By an Independent Central Bank
 Although there are pitfalls in allowing elected
policy makers a say in conducting monetary
policy, there is also an important advantage:
accountability.
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QuickQuiz
Should the governor of the Bank of
Canada be elected?
Explain.
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SHOULD THE CENTRAL BANK AIM
FOR ZERO INFLATION?
 How much inflation should the central bank be
willing to tolerate?
 Our third debate is whether zero is the right target
for the inflation rate.
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Pro: The Central Bank Should
Aim for Zero Inflation
 Inflation confers no benefit on society, but it
imposes several real costs.
 Economists have identified six costs of inflation.
 Some economists claim these costs can be
substantial, even for moderate inflation.
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Con: The Central Bank Should Not
Aim for Zero Inflation
 Although price stability may be desirable, the
benefits of zero inflation compared with
moderate inflation are small, whereas the costs of
reaching zero inflation are large.
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Active Learning
Another Issue in the Zero Inflation Debate
Suppose a structural change has reduced the demand
for university administrators, lowering their equilibrium
real wage by 3 percent.
A. If the actual real wage paid to university
administrators remains constant, what would be the
consequences?
B. Would it be easier to achieve the 3 percent real
wage reduction if the inflation rate is 0 percent or if
it is 4 percent? Why?
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Active Learning
Answers
A. If the actual real wage paid to university
administrators remains constant, what would be the
consequences?
Whenever the actual real wage exceeds the
equilibrium real wage, there is a surplus of labour,
which represents wasted resources.
A fall in the wage would encourage some
administrators to switch to university teaching or
private sector employment.
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Active Learning
Answers
B. Would it be easier to achieve the 3 percent real wage
reduction if the inflation rate is 0 percent or if it is 4
percent? Why?
To restore labour market equilibrium under 0 percent
inflation, administrators would have to accept a 3 percent
nominal wage cut.
Under 4 percent inflation, they would have to accept a
1 percent nominal wage increase.
The second scenario is more likely, as many people suffer
from “money illusion” and focus on nominal variables
rather than real ones.
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QuickQuiz
Explain the costs and benefits of reducing
inflation to zero.
Which are temporary and which are
permanent?
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SHOULD GOVERNMENTS
BALANCE THEIR BUDGETS?
 Should fiscal policy makers make balancing
the government’s budget a high priority?
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Pro: Governments Should
Balance Their Budgets
 The most direct effect of the
government debt is to place
a burden on future
generations of taxpayers.
 They lower national saving.
 They increase the default risk.
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Con: Governments Should Not
Balance Their Budgets
 The government debt does represent a tax
burden on younger generations, but it is not
large compared to the average person’s
lifetime income.
 It is misleading to view the effects of budget
deficits in isolation.
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QuickQuiz
Explain how reducing government debt
makes future generations better off.
What fiscal policy might improve the
lives of future generations more than
reducing the government debt?
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SHOULD TAX LAWS BE REFORMED
TO ENCOURAGE SAVING?
Should policy makers reform the tax laws to
encourage greater saving and investment?
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Pro: Tax Laws Should Be
Reformed to Encourage Saving
 International data show a strong correlation
between national saving rates and measures of
economic wellbeing.
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Con: Tax Laws Should Not Be
Reformed to Encourage Saving
 The problem with proposals to increase the
incentive to save is that they increase the tax
burden on those who can least afford it.
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QuickQuiz
Give three examples of how our society
discourages saving.
What are the drawbacks of eliminating
these disincentives?
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THE END
Chapter 17
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