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
Economic growth wikipedia , lookup
Steady-state economy wikipedia , lookup
Long Depression wikipedia , lookup
Economy of Italy under fascism wikipedia , lookup
Fiscal multiplier wikipedia , lookup
Non-monetary economy wikipedia , lookup
Ragnar Nurkse's balanced growth theory wikipedia , lookup
Business cycle wikipedia , lookup
Transformation in economics wikipedia , lookup
Five Debates Over Macroeconomic Policy + Revision Mankiw and Taylor, Chapter 39 In discussing these debates the aim is to review and revise existing material, not introduce new material •www.le.ac.uk Five (+2) Debates over Macroeconomic Policy 1. If only we knew what we know! 2. Are structural deficits real or not? 3. Should the government balance its budget? 4. Do we need macro-prudential policy? 5. How did economists get it so wrong? Other ongoing debates, which again are useful revision are: 1. Should monetary and fiscal policymakers try to stabilise the economy? 2. Should the tax laws be reformed to encourage saving? There is no “right” answer • Individual opinions • Political considerations • Power and rent-seeking involved 1. If only we knew what we know! • Pro: Information Helps Make Accurate Decisions • Con: Economic Forecasting is Nothing More than a Con-Trick – Black Swan events mean we never know for sure what is going to happen – Most economists missed the financial crisis in 2007 – Need to use data and forecasts acknowledging their uncertainties 2. Are structural deficits real or not? • Cyclical versus structural deficits – Deficits rise in a recession. Structural deficits are when there is a deficit irrespective of the business cycle • Pro: Policy makers need to eradicate structural deficits – So that when countries enter a recession their debt levels are manageable • Con: Structural deficits are a myth – We cannot measure the ‘output gap’ reliably 3. Should the government balance its budget? Revision. An aside on the loanable funds model: investment tax credits affect the demand curve Pro: The government should balance its budget • Budget deficits impose an unjustifiable burden on future generations by raising their taxes and lowering their incomes • When the debts and accumulated interest come due, future taxpayers will face a difficult choice: – They can pay higher taxes, enjoy less government spending, or both Pro: The government should balance its budget • By shifting the cost of current government benefits to future generations, there is a bias against future taxpayers • Deficits reduce national saving, leading to a smaller stock of capital, which reduces productivity and growth Con: The government should not balance its budget • The problem with the deficit is often exaggerated • The transfer of debt to the future may be justified because some government purchases produce benefits well into the future – e.g. spending on education today, even if it means running a deficit, may pay off in the future with higher GDP growth – It’s an investment Con: The government should not balance its budget • Government debt can continue to rise because population growth and technological progress increase the nation’s ability to pay the interest on the debt • That is, we need to look not at debt, but at debt to GDP ratios – And as long as Debt ↑ no more quickly than nominal GDP then Debt/GDP is stable 4. Do we need macro-prudential policy? • Pro: Financial crisis was down to leverage and excessive risk taking by many banks – Macro-prudential policy would monitor banks’ capital ratios and seek to minimise their risk taking, especially when they’re “too big to fail” • Con: Impossible to detect excessive risk-taking (and financial bubbles) in “real-time” – Banks will find ways round the rules in any case, even if countries can agree on common rules 5. How did economists get it so wrong? • Belief in efficient markets; and • Distrust of government intervention The efficient markets hypothesis – Asset prices reflect all publicly available information about the value of an asset → Price = Value. Prices move only as info changes – Each company listed on a major stock exchange is followed closely by many money managers • and they buy shares whose price < value and sell those whose price > value • ‘If an economist had a formula that could reliably forecast prices a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier’ • Equilibrium of supply and demand sets the market price, so all shares are fairly valued 14 EMH • Stock markets – Exhibit informational efficiency • Informational efficiency – Asset prices reflect all available information • At a given point in time, the market price is the best guess of the stock’s value • Prices only change as new information (news) arrives. But this news arrives randomly… • Implication of efficient markets hypothesis – Stock prices should follow a random walk • Future changes in stock prices are impossible to predict from currently available information 15 Implications of the EMH • If prices do reflect all available information and are correctly valued, then no stock is a better buy than any other • The best you can do is buy a diversified portfolio (an index fund) like a mutual fund which buys all the stocks in an index – to minimise idiosyncratic risk – Can’t beat the market on a risk-adjusted basis – There is no means of picking winners and losers 16 Economics got it wrong • There was too much trust in the ideas that people behave rationally and that the market is the best way to allocate resources • But (new) Keynesians believe that while in the longrun wages and prices may adjust to restore output at its natural rate, there can be significant short-run deviations with unemployment higher than its natural rate – Does this imply a role for governments to stimulate the economy, given deficient demand? Efficient markets still have some currency • Efficient markets mean precisely that it is impossible to predict the future (and impossible to predict crises like the one in 2007/8) • Markets may get it wrong (experience bubbles) but they remain preferable to government intervention Other Debates, and a chance to review some of the main models in this course 1. Should monetary and fiscal policymakers try to stabilise the economy? Pro: Policymakers should try to stabilise the economy • The economy is inherently unstable, and left on its own will fluctuate • Policy can manage aggregate demand in order to offset this inherent instability and reduce the severity of economic fluctuations Pro: Policymakers should try to stabilise the economy • There is no reason for society to suffer through the booms and busts of the business cycle • Monetary and fiscal policy can stabilise aggregate demand and, thereby, production and employment Con: Policymakers should not try to stabilise the economy • Monetary policy affects the economy with long and unpredictable lags between the need to act and the time that it takes for these policies to work • Many studies indicate that changes in monetary policy have little effect on aggregate demand until about six months after the change is made Con: Policymakers should not try to stabilise the economy • Fiscal policy works with a lag because of the long political process that governs changes in spending and taxes • It can take years to propose, pass, and implement a major change in fiscal policy Con: Policymakers should not try to stabilise the economy • All too often policymakers can inadvertently exacerbate rather than mitigate the magnitude of economic fluctuations • It might be desirable if policy makers could eliminate all economic fluctuations, but this is not a realistic goal Causes of Economic Fluctuations • Shift in aggregate demand – Wave of pessimism (credit crunch) – Aggregate demand shifts left – Short-run fluctuations: the business cycle • Output falls • Price level falls – Long-run • Short-run aggregate supply curve shifts right • Output reverts to it natural rate (so does this mean there’s no need for government to intervene?) • Price level falls (to offset shift in AD) 25 Exhibit 8 A Contraction in Aggregate Demand Price Level Long-run Short-run aggregate aggregate supply supply, AS1 AS2 P1 3. . . . but over time, the short-run aggregate-supply curve shifts . . . A B P2 C 4. . . . and output returns to its natural rate. P3 1. A decrease in aggregate demand . . . AD2 Y2 Aggregate demand, AD1 Y1 Quantity of Output 2. . . . causes output to fall in the short run . . . A fall in aggregate demand is represented with a leftward shift in the aggregate-demand curve from AD1 to AD2. In the short run, the economy moves from point A to point B. Output falls from Y1 to Y2, and the price level falls from P1 to P2. Over time, as the expected price level adjusts, the short-run aggregate-supply curve shifts to the right from AS1 to AS2, and the economy reaches point C, where the new aggregate-demand curve crosses the long-run aggregate-supply curve. In the long run, the price level falls to P3, and output returns to its natural rate, Y1. 26 AD-SRAS/LRAS model • Model of long run: Vertical long-run AS curve • Model of short run: Upward sloping short-run AS curve – 3 explanations for why this SRAS is upward sloping • Sticky wages • Sticky prices • Misperceptions SRAS Curve: in summary • All three theories imply that: Quantity of output supplied = = Natural rate of output + + a(Actual price level – Expected price level) • where a determines how much output responds to unexpected changes in the price level • But in the long run, actual prices = expected prices and SRAS = LRAS = vertical 28 The Long-Run Equilibrium Price Level Equilibrium price Long-run aggregate supply Short-run aggregate supply A Natural rate of output Aggregate demand Quantity of Output The long-run equilibrium of the economy is found where the aggregate-demand curve crosses the long-run aggregate-supply curve (point A). When the economy reaches this long-run equilibrium, the expected price level will have adjusted to equal the actual price level. As a result, the short-run aggregate-supply curve crosses this point as well. 29 Shifts to the SRAS curve • The short-run AS curve might shift because of: – Changes in labour, capital, natural resources, or technological knowledge • i.e. all those factors that explained movements in the LRAS curve (since they shift SRAS and LRAS), but also – Expected price level increases and the SRAS curve shifts to the left (up) – i.e. SRAS curve depends on sticky wages, sticky prices and misperceptions. Since these are all set based on expectations of prices, when price expectations change the SRAS shifts – In the short run expectations are fixed and economy is at the intersection of the AD and SRAS curves – But we will see that, in the long run, expectations shift to ensure intersection of the AD and LRAS curves 30 Table 2 The Short-Run Aggregate-Supply Curve: Summary 31 Table 2 The Short-Run Aggregate-Supply Curve: Summary 32 2. Should the tax laws be reformed to encourage saving? Pro: Tax laws should be reformed to encourage saving • A nation’s saving rate is a key determinant of its long-run economic prosperity • A nation’s productive capability is determined largely by how much it saves and invests for the future • When the saving rate is higher, more resources are available for investment in new plant and equipment Saving and Investment • Raise future productivity – Invest more current resources in the production of capital – Trade-off • This involves devoting fewer resources to produce goods and services for current consumption • To invest more in capital, a society must consume less and save more of its current income • Financial markets coordinate S and I in market economies. Governments can also affect S and I, and therefore economic growth 35 Diminishing Returns • Higher savings rate – Fewer resources are need to make consumption goods – So there are more resources to make capital goods – Capital stock increases – Rising productivity – More rapid growth in GDP • But there can be difficulties in inferring causation from correlation (in principle, GDP could be causing Investment, not the other way round) 36 Diminishing Returns • Diminishing returns – Benefit from an extra unit of an input declines as the quantity of the input increases • In the long run, higher savings rate → – Higher level of productivity – Higher level of income but not higher growth in productivity or income – But the long-run can be a long time coming 37 Figure Illustrating the Production Function Output per Worker 1 1 2. When the economy has a high level of capital, an extra unit of capital leads to a small increase in output. 1. When the economy has a low level of capital, an extra unit of capital leads to a large increase in output. Capital per Worker This figure shows how the amount of capital per worker influences the amount of output per worker. Other determinants of output, including human capital, natural resources, and technology, are held constant. The curve becomes flatter as the amount of capital increases because of diminishing returns to capital. 38 Productivity • Productivity – Quantity of goods and services produced from each unit of labour input • Why productivity is so important – Key determinant of living standards – Growth in productivity is the key determinant of growth in living standards – An economy’s income is the economy’s output 39 Pro: Tax laws should be reformed to encourage saving • The tax system discourages saving in many ways, such as by heavily taxing the income from capital and by reducing benefits for those who have accumulated wealth Pro: Tax laws should be reformed to encourage saving • The consequences of high capital income tax policies are reduced saving, reduced capital accumulation, lower labor productivity, and reduced economic growth Pro: Tax laws should be reformed to encourage saving • An alternative to current tax policies advocated by many economists is a consumption tax • With a consumption tax, a household pays taxes based on what it spends not on what it earns – Income that is saved is exempt from taxation until the saving is later withdrawn and spent on consumption goods Con: Tax laws should not be reformed to encourage saving • Many of the changes in tax laws to stimulate saving would primarily benefit the wealthy – High-income households save a higher fraction of their income than low-income households – Any tax change that favours people who save will also tend to favour people with high incomes