Chapter 23 - Six Debates Over Macroeconomic Policy

23.1: Should Monetary and Fiscal Policymakers Try to Stabilize the Economy?

Pro: Policymakers Should Try to Stabilize the Economy:

Monetary and fiscal policy can stabilize aggregate demand
- Including production and employment
When aggregate demand is inadequate to ensure full employment
- Policymakers should boost government spending, cut taxes, and expand the money supply
When aggregate demand is excessive, risking high inflation
- Policymakers should cut government spending, raise taxes, and reduce the money supply
Not only do all these points lead to a more stable economy, it benefits everyone

Con: Policymakers Should Not Try to Stabilize the Economy

Monetary and fiscal policy do not affect the economy immediately
- It works with a long lag
Monetary policy affects aggregate demand primarily by changing interest rates
- Affect spendings, residential and business investments
- But many households and firms set their spending plans in advance
- Takes time for changes in interest rates to alter the aggregate demand for goods and services
Fiscal policy works with a lag because of the long political process that governs changes in spending and taxes
- In order to make changes in the fiscal policy, a bill must go through congressional committees
- The house, the senate, and signed by the president

Pro: The Government Should Fight Recessions with Spending Hikes:

The key to ending recessions is to restore aggregate demand to a level consistent with full employment of the economy’s labor force

Con: The Government Should Fight Recessions with Tax Cuts:

Tax cuts have important influence on both aggregate demand and aggregate supply
- They increase aggregate demand by increasing households’ disposable income
- If tax reduction takes the form of an expanded investment tax credit, they can induce increased spending on investment and goods

Pro: Monetary Policy Should Be Made by Rule:

Discretion in the conduct of monetary policy has two problems
- Abuse of power
- Bankers are tempted to use monetary policy to affect the outcome of elections
- Might lead to more inflation than is desirable

Con: Monetary Policy Should Not Be Made by Rule:

Alleged problems with discretion are largely hypothetical
Bankers are trustable with their words because they can achieve credibility over time by backing their words with their actions

Pro: The Central Bank Should Aim for Zero Inflation:

Trade-offs will improve
- No need for a trade-off between inflation and unemployment
A policy that comes with temporary costs and permanent benefits
- Benefits of zero inflation in the future
Zero provides a more natural focal point for policymakers than any other number

Con: The Central Bank Should Not Aim for Zero Inflation:

When the economy goes into recession, all incomes do not fall proportionately
- The fall in aggregate income is concentrated on those workers who lose their jobs
Inflation allows for the possibility of negative real interest rates
- If inflation is zero, real interest rates can never be negative as well

Pro: The Government Should Balance Its Budget:

U.S. federal government is indebted
- Can place a burden on future generations of taxpayers if there’s no set budget
When the government runs a budget deficit and issues government debt, it allows current taxpayers to pass the bill for some of their government spending on to future taxpayers
Budget deficits represent negative public savings
- Lower the living standard for future generations

Con: The Government Should Not Balance Its Budget:

The problem with government debt is often exaggerated
Misleading to view the effects of budget deficits in isolation
Critics of budget deficits sometimes assert that the government debt cannot continue to rise forever
- But it can- the nation’s ability to pay the interest on the government debt grows over time as well
- Nothing to prevent the government debt from growing forever
- As population growth and technological progress cause the total income of the U.S. economy to grow over time

Pro: The Tax Laws Should Be Reformed to Encourage Saving:

When the saving rate is higher, more resources are available for investment in new plant and equipment
- Larger stock of plant and equipment raises labor productivity, wages, and incomes

Con: The Tax Laws Should Not Be Reformed to Encourage Saving:

Tax changes that reduce the taxation of capital income reduce government revenue
- Lead to a larger budget deficit
Economic theory does not give a clear prediction about whether a higher rate of return would increase saving

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