Chapter 34d

8/9/2019 Chapter 34d

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Five Debates overMacroeconomic

Policy

Chapter 34

Copyright 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of

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work should be mailed to:Permissions Department, arcourt !ollege Publishers,


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arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.

Five Debates over

Macroeconomic Policy1. Should monetary and fiscal

policymakers try to stabilie the

economy!

2. Should monetary policy be made by

rule rather than by discretion!

". Should the central bank aim for ero

inflation!


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Five Debates over

Macroeconomic Policy#. Should the go$ernment balance its

budget!

%. Should the ta& la's be reformed to

encourage sa$ing!


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1. Should Monetary and

Fiscal Policymakers Try to

Stabilie the !conomy"


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Pro# Policymakers should try

to stabilie the economy (he economy is inherently unstable, and

left on its o'n 'ill fluctuate.

)olicy can manage aggregate demand in

order to offset this inherent instability

and reduce the se$erity of economic

fluctuations.


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Pro# Policymakers should try

to stabilie the economy (here is no reason for society to suffer

through the booms and busts of the

business cycle. *onetary and fiscal policy can stabilie

aggregate demand and, thereby,

production and employment.


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Con# Policymakers should not

try to stabilie the economy *onetary policy affects the economy

'ith long and unpredictable lags bet'een

the need to act and the time that it takesfor these policies to 'ork.

*any studies indicate that changes in

monetary policy ha$e little effect onaggregate demand until about si& months

after the change is made.


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try to stabilie the economy +iscal policy 'orks 'ith a lag because of

the long political process that go$erns

changes in spending and ta&es. It can take years to propose, pass, and

implement a maor change in fiscal

policy.


9/37arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.


try to stabilie the economy -ll too often policymakers can

inad$ertently e&acerbate rather than

mitigate the magnitude of economicfluctuations.

It might be desirable if policy makers

could eliminate all economic fluctuations,but this is not a realistic goal.



$. Should Monetary Policy

%e Made by &ule &atherThan by Discretion"



Pro# Monetary policy should be

made by rule iscretionary monetary policy can suffer

from incompetence and abuse of po'er.

(o the e&tent that central bankers ally

themsel$es 'ith politicians, discretionary

policy can lead to economic fluctuations

that reflect the electoral calendar / thepolitical business cycle.




made by rule (here may be a discrepancy bet'een 'hat

policymakers say they 'ill do and 'hat

they actually do / called time inconsistencyof policy.

ecause policymakers are so often time

inconsistent, people are skeptical 'hencentral bankers announce their intentions

to reduce the rate of inflation.




made by rule

Committing the +ed to a moderate and

steady gro'th of the money supply 'ouldlimit incompetence, abuse of po'er, and

time inconsistency.



Con# Monetary policy should

not be made by rule

-n important ad$antage of discretionary

monetary policy is its fle&ibility.

Infle&ible policies 'ill limit the ability of

policymakers to respond to changing

economic circumstances.



Con# Monetary policy should

not be made by rule (he alleged problems 'ith discretion and

abuse of po'er are largely hypothetical.

-lso, the importance of the political

business cycle is far from clear.



3. Should The Central %ank'im (or )ero *n(lation"



Pro# The central bank should

aim (or ero in(lation Inflation confers no benefit to society, but

it imposes se$eral real costs.

Shoeleather costs

*enu costs

Increased $ariability of relati$e prices

nintended changes in ta& liabilities Confusion and incon$enience

-rbitrary redistribution of 'ealth



Pro# The central bank should

aim (or ero in(lation educing inflation is a policy 'ith

temporary costs and permanent benefits.

3nce the disinflationary recession is o$er,

the benefits of ero inflation 'ould

persist.



Con# The central bank should

not aim (or ero in(lation 4ero inflation is probably unattainable,

and to get there in$ol$es output,

unemployment, and social costs that aretoo high.

)olicymakers can reduce many of the

costs of inflation 'ithout actuallyreducing inflation.



4. Should Fiscal

Policymakers reduce the+overnment Debt"



Pro# The ,overnment should

balance its bud,et

udget deficits impose an unustifiable

burden on future generations by raising

their ta&es and lo'ering their incomes. 5hen the debts and accumulated interest

come due, future ta&payers 'ill face a

difficult choice6 (hey can pay higher ta&es, enoy less

go$ernment spending, or both.



Pro# The ,overnment should

balance its bud,et y shifting the cost of current go$ernment

benefits to future generations, there is a

bias against future ta&payers. eficits reduce national sa$ing, leading to

a smaller stock of capital, 'hich reduces

producti$ity and gro'th.



Con# The ,overnment should

not balance its bud,et (he problem 'ith the deficit is often

e&aggerated.

(he transfer of debt to the future may be

ustified because some go$ernment

purchases produce benefits 'ell into the

future.



Con# The ,overnment should

not balance its bud,et

(he go$ernment debt can continue to rise

because population gro'th andtechnological progress increase the

nation7s ability to pay the interest on the

debt.



-. Should The Ta /a0s %e

&e(ormed to !ncoura,eSavin,"



Pro# Ta la0s should be re(ormed

to encoura,e savin, - nation7s sa$ing rate is a key determinant

of its long8run economic prosperity.

- nation7s producti$e capability isdetermined largely by ho' much it sa$es

and in$ests for the future.

5hen the sa$ing rate is higher, moreresources are a$ailable for in$estment in

ne' plant and e9uipment.




to encoura,e savin, (he .S. ta& system discourages sa$ing in

many 'ays, such as by hea$ily ta&ing the

income from capital and by reducing

benefits for those 'ho ha$e accumulated

'ealth.


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to encoura,e savin, (he conse9uences of high capital income

ta& policies are reduced sa$ing, reduced

capital accumulation, lo'er labor

producti$ity, and reduced economic

gro'th.


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Pro# Ta la0s should be

re(ormed to encoura,e savin, -n alternati$e to current ta& policies

ad$ocated by many economists is a

consumption ta&. 5ith a consumption ta&, a household pays

ta&es based on 'hat it spends not on 'hat it

earns. Income that is sa$ed is e&empt from ta&ation

until the sa$ing is later 'ithdra'n and spent on

consumption goods.


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Con# Ta la0s should not be

re(ormed to encoura,e savin, *any of the changes in ta& la's to

stimulate sa$ing 'ould primarily benefit

the 'ealthy. High8income households sa$e a higher

fraction of their income than lo'8income

households. -ny ta& change that fa$ors people 'ho sa$e

'ill also tend to fa$or people 'ith high

incomes.


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re(ormed to encoura,e savin,

educing the ta& burden on the 'ealthy

'ould lead to a less egalitarian society. (his 'ould also force the go$ernment to

raise the ta& burden on the poor.


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re(ormed to encoura,e savin,

aising public sa$ing by eliminating the

go$ernment7s budget deficit 'ouldpro$ide a more direct and e9uitable 'ay

to increase national sa$ing.


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Summary

-d$ocates of acti$e monetary and fiscalpolicy $ie' the economy as inherently

unstable and belie$e policy can be used to

offset this inherent instability. Critics of acti$e policy emphasie that policy

affects the economy 'ith a lag and our

ability to forecast future economic conditionsis poor, both of 'hich can lead to policy

being destabiliing.


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Summary

-d$ocates of rules for monetary policy

argue that discretionary policy can suffer

from incompetence, abuse of po'er, and

time inconsistency.

Critics of rules for monetary policy argue

that discretionary policy is more fle&ible

in responding to economic circumstances.


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Summary

-d$ocates of a ero8inflation target

emphasie that inflation has many costs

and fe' if any benefits.

Critics of a ero8inflation target claim

that moderate inflation imposes only

small costs on society, 'hereas the

recession necessary to reduce inflation is

9uite costly.


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Summary

-d$ocates of reducing the go$ernment

debt argue that the debt imposes a

burden on future generations by raising

their ta&es and lo'ering their incomes. Critics of reducing the go$ernment debt

argue that the debt is only one small

piece of fiscal policy.


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Summary

-d$ocates of ta& incenti$es for sa$ing point out

that our society discourages sa$ing in many

'ays such as ta&ing income from capital and

reducing benefits for those 'ho ha$eaccumulated 'ealth.

Critics of ta& incenti$es argue that many

proposed changes to stimulate sa$ing 'ouldprimarily benefit the 'ealthy and also might

ha$e only a small effect on pri$ate sa$ing.

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Chapter 34d

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