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Chapter 18:
“The Economic
Way of Thinking”
11th Edition
Economic
Performance
and Political
Economy
© 2006 Prentice Hall Business Publishing
The Economic Way of Thinking, 11/e
Heyne/Boettke/Prychitko
Chapter 18 Outline
• Introduction
• The Political Setting
• The Horizons and the Sequence of Effects
• Deficits Unlimited
• Why Not Government at All Levels?
• The Political Economy of Monetary Policy
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Chapter 18 Outline
• Discretion and Rules
• Who is at the Controls?
• Renewal of the Debate
• What Lies Ahead?
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Introduction
• Policy makers talk about public interest
– Actually respond to pressures of narrower interests
• Results of such policies
– Less stability rather than more
– Stagnation rather than economic growth
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The Political Setting
• Public Policy
– Reflects the interests of those who can extract
benefits of the political process at a low cost.
• Preferred Policies
– Short-term benefits and long-term costs.
• Public Policy
– Reflects the ability of interested parties to articulate
their request and monitor the politicians’ response.
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Time Horizons and the
Sequence of Effects
• Changes in Aggregate Demand
– Affects output and employment before affecting
prices.
• Politically
– Expansionary policy is preferred over contractionary
policy because…
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Time Horizons and the
Sequence of Effects
• Politically
– Favor policies yielding benefits on
• Well organized and well informed interest groups
• In the short run
• At the expense of costs borne by unorganized and
ill-informed mass of voters.
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Deficits Unlimited
Why do budget deficits persist when there is
a majority support for a balanced budget?
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Deficits Unlimited
1990
-$221.2
1997
-$ 22.0
1991
-$269.3
1998
+$ 69.2
1992
-$290.4
1999
+$125.6
1993
-$255.1
2000
+$236.4
1994
-$203.2
2001
+$127.4
1995
-$164.0
2002
-$157.8
1996
-$107.5
2003
-$375.3
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Deficits Unlimited
WHAT DO YOU THINK?
Are Congress and the President
responsible for eliminating the deficit?
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Why Not Government at All Levels?
• State and local governments do not produce
chronic deficits.
• The federal government did not produce chronic
deficits prior to the 1970’s.
• State and local governments do not have control
over the medium of exchange.
• Strong majority convictions influence public
policy.
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Why Not Government at All Levels?
Federal Government Debt as Percentage of GDP
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
1999
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118%
94
69
56
47
38
35
33
44
56
68
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Why Not Government at All Levels?
How did Keynesian economics impact our
willingness to accept federal budget deficits?
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The Political Economy
of Monetary Policy
• Question
– Can the Fed prevent chronic deficits?
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The Political Economy
of Monetary Policy
• Can the Fed prevent chronic deficits?
– Fed is organized as an independent agency.
– Congress could rewrite the Federal Reserve Act.
– Radical action by Congress could create uncertainty
over inflation.
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Discretion and Rules
•
An Alternative to Discretionary Fiscal and
Monetary Policy
1. Government expenditures without reference to a
stabilization goal.
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Discretion and Rules
•
An Alternative to Discretionary Fiscal and
Monetary Policy
2. Tax rates set to balance the budget over a normal
period.
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Discretion and Rules
•
An Alternative to Discretionary Fiscal and
Monetary Policy
3. The Fed should maintain a constant money stock for
allowing moderate growth.
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Who Is at the Controls?
Would a balanced budget amendment
eliminate deficit spending and help stabilize
the economy?
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Renewal of the Debate
• Question
– Do markets allocate resources efficiently?
• Late 1980s and early 1990s
– Capitalism reigned as the solution to the allocation
questions.
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Renewal of the Debate
• Late 1990s
– Economic difficulties in Russia, Brazil and the Pacific
rim drew new attention to the economic role of
government.
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Renewal of the Debate
• Question
– What has caused the economic problems in:
• Russia?
• Japan?
• Malaysia and Indonesia?
• Brazil?
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Renewal of the Debate
• Question
– Is it failed policy or simply market adjustments?
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What Lies Ahead?
What do you think…?
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Once Over Lightly
• Policymakers controlled by political processes.
• Stabilization policies affected by short time
horizons.
• Unanticipated change in rate of growth of
demand will affect output and employment
before costs and prices.
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Once Over Lightly
• Political process tends to produce chronic
budget deficits.
• Government contribution to economic stability
might be to do “less”.
• Discretion stabilization policy vs. fixed rules.
• Economic failures in late 1990’s renewed debate
over roles of governments and markets.
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End of Chapter 18
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