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5
FINAL THOUGHTS
Copyright © 2004 South-Western
2828Five Debates Over
Macroeconomic
Policy
Copyright © 2004 South-Western
Five Debates over Macroeconomic
Policy
1.Should monetary and fiscal policymakers try to
stabilize the economy?
2.Should monetary policy be made by rule rather
than by discretion?
3.Should the central bank aim for zero inflation?
4.Should the government balance its budget?
5.Should the tax laws be reformed to encourage
saving?
Copyright © 2004 South-Western
1. Should monetary and fiscal
policymakers try to stabilize the
economy?
Copyright © 2004 South-Western
Pro: Policymakers should try to
stabilize 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.
Copyright © 2004 South-Western
Pro: Policymakers should try to
stabilize the economy
• There is no reason for society to suffer through
the booms and busts of the business cycle.
• Monetary and fiscal policy can stabilize
aggregate demand and, thereby, production and
employment.
Copyright © 2004 South-Western
Con: Policymakers should not try to
stabilize 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.
Copyright © 2004 South-Western
Con: Policymakers should not try to
stabilize 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.
Copyright © 2004 South-Western
Con: Policymakers should not try to
stabilize 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.
Copyright © 2004 South-Western
2. Should monetary policy be made by
rule rather than by discretion?
Copyright © 2004 South-Western
Pro: Monetary policy should be
made by rule
• Discretionary monetary policy can suffer from
incompetence and abuse of power.
• To the extent that central bankers ally
themselves with politicians, discretionary
policy can lead to economic fluctuations that
reflect the electoral calendar—the political
business cycle.
Copyright © 2004 South-Western
Pro: Monetary policy should be
made by rule
• There may be a discrepancy between what
policymakers say they will do and what they
actually do—called time inconsistency of
policy.
• Because policymakers are so often time
inconsistent, people are skeptical when central
bankers announce their intentions to reduce the
rate of inflation.
Copyright © 2004 South-Western
Pro: Monetary policy should be
made by rule
• Committing the Fed to a moderate and steady
growth of the money supply would limit
incompetence, abuse of power, and time
inconsistency.
Copyright © 2004 South-Western
Con: Monetary policy should not be
made by rule
• An important advantage of discretionary
monetary policy is its flexibility.
• Inflexible policies will limit the ability of
policymakers to respond to changing economic
circumstances.
Copyright © 2004 South-Western
Con: Monetary policy should not be
made by rule
• The alleged problems with discretion and abuse
of power are largely hypothetical.
• Also, the importance of the political business
cycle is far from clear.
Copyright © 2004 South-Western
3. Should the central bank aim for zero
inflation?
Copyright © 2004 South-Western
Pro: The central bank should aim for
zero inflation
• Inflation confers no benefit to society, but it
imposes several real costs.
• Shoeleather costs
• Menu costs
• Increased variability of relative prices
• Unintended changes in tax liabilities
• Confusion and inconvenience
• Arbitrary redistribution of wealth
Copyright © 2004 South-Western
Pro: The central bank should aim for
zero inflation
• Reducing inflation is a policy with temporary
costs and permanent benefits.
• Once the disinflationary recession is over, the
benefits of zero inflation would persist.
Copyright © 2004 South-Western
Con: The central bank should not
aim for zero inflation
• Zero inflation is probably unattainable, and to
get there involves output, unemployment, and
social costs that are too high.
• Policymakers can reduce many of the costs of
inflation without actually reducing inflation.
Copyright © 2004 South-Western
4.Should fiscal policymakers reduce
the government debt?
Copyright © 2004 South-Western
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.
Copyright © 2004 South-Western
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.
Copyright © 2004 South-Western
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.
Copyright © 2004 South-Western
Con: The government should not
balance its budget
• The government debt can continue to rise
because population growth and technological
progress increase the nation’s ability to pay the
interest on the debt.
Copyright © 2004 South-Western
5.Should the tax laws be reformed to
encourage saving?
Copyright © 2004 South-Western
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.
Copyright © 2004 South-Western
Pro: Tax laws should be reformed to
encourage saving
• The U.S. 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.
Copyright © 2004 South-Western
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.
Copyright © 2004 South-Western
Pro: Tax laws should be reformed to
encourage saving
• An alternative to current tax policies advocated
by many economists is a consumption taxconsumption 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.
Copyright © 2004 South-Western
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 favors people who save will
also tend to favor people with high incomes.
Copyright © 2004 South-Western
Con: Tax laws should not be
reformed to encourage saving
• Reducing the tax burden on the wealthy would
lead to a less egalitarian society.
• This would also force the government to raise
the tax burden on the poor.
Copyright © 2004 South-Western
Con: Tax laws should not be
reformed to encourage saving
• Raising public saving by eliminating the
government’s budget deficit would provide a
more direct and equitable way to increase
national saving.
Copyright © 2004 South-Western
Summary
• Advocates of active monetary and fiscal policy
view the economy as inherently unstable and
believe policy can be used to offset this
inherent instability.
• Critics of active policy emphasize that policy
affects the economy with a lag and our ability
to forecast future economic conditions is poor,
both of which can lead to policy being
destabilizing.
Copyright © 2004 South-Western
Summary
• Advocates of rules for monetary policy argue
that discretionary policy can suffer from
incompetence, abuse of power, and time
inconsistency.
• Critics of rules for monetary policy argue that
discretionary policy is more flexible in
responding to economic circumstances.
Copyright © 2004 South-Western
Summary
• Advocates of a zero-inflation target emphasize
that inflation has many costs and few if any
benefits.
• Critics of a zero-inflation target claim that
moderate inflation imposes only small costs on
society, whereas the recession necessary to
reduce inflation is quite costly.
Copyright © 2004 South-Western
Summary
• Advocates of reducing the government debt
argue that the debt imposes a burden on future
generations by raising their taxes and lowering
their incomes.
• Critics of reducing the government debt argue
that the debt is only one small piece of fiscal
policy.
Copyright © 2004 South-Western
Summary
• Advocates of tax incentives for saving point out
that our society discourages saving in many
ways such as taxing income from capital and
reducing benefits for those who have
accumulated wealth.
• Critics of tax incentives argue that many
proposed changes to stimulate saving would
primarily benefit the wealthy and also might
have only a small effect on private saving.

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28 five debates

  • 2. Copyright © 2004 South-Western 2828Five Debates Over Macroeconomic Policy
  • 3. Copyright © 2004 South-Western Five Debates over Macroeconomic Policy 1.Should monetary and fiscal policymakers try to stabilize the economy? 2.Should monetary policy be made by rule rather than by discretion? 3.Should the central bank aim for zero inflation? 4.Should the government balance its budget? 5.Should the tax laws be reformed to encourage saving?
  • 4. Copyright © 2004 South-Western 1. Should monetary and fiscal policymakers try to stabilize the economy?
  • 5. Copyright © 2004 South-Western Pro: Policymakers should try to stabilize 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.
  • 6. Copyright © 2004 South-Western Pro: Policymakers should try to stabilize the economy • There is no reason for society to suffer through the booms and busts of the business cycle. • Monetary and fiscal policy can stabilize aggregate demand and, thereby, production and employment.
  • 7. Copyright © 2004 South-Western Con: Policymakers should not try to stabilize 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.
  • 8. Copyright © 2004 South-Western Con: Policymakers should not try to stabilize 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.
  • 9. Copyright © 2004 South-Western Con: Policymakers should not try to stabilize 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.
  • 10. Copyright © 2004 South-Western 2. Should monetary policy be made by rule rather than by discretion?
  • 11. Copyright © 2004 South-Western Pro: Monetary policy should be made by rule • Discretionary monetary policy can suffer from incompetence and abuse of power. • To the extent that central bankers ally themselves with politicians, discretionary policy can lead to economic fluctuations that reflect the electoral calendar—the political business cycle.
  • 12. Copyright © 2004 South-Western Pro: Monetary policy should be made by rule • There may be a discrepancy between what policymakers say they will do and what they actually do—called time inconsistency of policy. • Because policymakers are so often time inconsistent, people are skeptical when central bankers announce their intentions to reduce the rate of inflation.
  • 13. Copyright © 2004 South-Western Pro: Monetary policy should be made by rule • Committing the Fed to a moderate and steady growth of the money supply would limit incompetence, abuse of power, and time inconsistency.
  • 14. Copyright © 2004 South-Western Con: Monetary policy should not be made by rule • An important advantage of discretionary monetary policy is its flexibility. • Inflexible policies will limit the ability of policymakers to respond to changing economic circumstances.
  • 15. Copyright © 2004 South-Western Con: Monetary policy should not be made by rule • The alleged problems with discretion and abuse of power are largely hypothetical. • Also, the importance of the political business cycle is far from clear.
  • 16. Copyright © 2004 South-Western 3. Should the central bank aim for zero inflation?
  • 17. Copyright © 2004 South-Western Pro: The central bank should aim for zero inflation • Inflation confers no benefit to society, but it imposes several real costs. • Shoeleather costs • Menu costs • Increased variability of relative prices • Unintended changes in tax liabilities • Confusion and inconvenience • Arbitrary redistribution of wealth
  • 18. Copyright © 2004 South-Western Pro: The central bank should aim for zero inflation • Reducing inflation is a policy with temporary costs and permanent benefits. • Once the disinflationary recession is over, the benefits of zero inflation would persist.
  • 19. Copyright © 2004 South-Western Con: The central bank should not aim for zero inflation • Zero inflation is probably unattainable, and to get there involves output, unemployment, and social costs that are too high. • Policymakers can reduce many of the costs of inflation without actually reducing inflation.
  • 20. Copyright © 2004 South-Western 4.Should fiscal policymakers reduce the government debt?
  • 21. Copyright © 2004 South-Western 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.
  • 22. Copyright © 2004 South-Western 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.
  • 23. Copyright © 2004 South-Western 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.
  • 24. Copyright © 2004 South-Western Con: The government should not balance its budget • The government debt can continue to rise because population growth and technological progress increase the nation’s ability to pay the interest on the debt.
  • 25. Copyright © 2004 South-Western 5.Should the tax laws be reformed to encourage saving?
  • 26. Copyright © 2004 South-Western 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.
  • 27. Copyright © 2004 South-Western Pro: Tax laws should be reformed to encourage saving • The U.S. 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.
  • 28. Copyright © 2004 South-Western 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.
  • 29. Copyright © 2004 South-Western Pro: Tax laws should be reformed to encourage saving • An alternative to current tax policies advocated by many economists is a consumption taxconsumption 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.
  • 30. Copyright © 2004 South-Western 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 favors people who save will also tend to favor people with high incomes.
  • 31. Copyright © 2004 South-Western Con: Tax laws should not be reformed to encourage saving • Reducing the tax burden on the wealthy would lead to a less egalitarian society. • This would also force the government to raise the tax burden on the poor.
  • 32. Copyright © 2004 South-Western Con: Tax laws should not be reformed to encourage saving • Raising public saving by eliminating the government’s budget deficit would provide a more direct and equitable way to increase national saving.
  • 33. Copyright © 2004 South-Western Summary • Advocates of active monetary and fiscal policy view the economy as inherently unstable and believe policy can be used to offset this inherent instability. • Critics of active policy emphasize that policy affects the economy with a lag and our ability to forecast future economic conditions is poor, both of which can lead to policy being destabilizing.
  • 34. Copyright © 2004 South-Western Summary • Advocates of rules for monetary policy argue that discretionary policy can suffer from incompetence, abuse of power, and time inconsistency. • Critics of rules for monetary policy argue that discretionary policy is more flexible in responding to economic circumstances.
  • 35. Copyright © 2004 South-Western Summary • Advocates of a zero-inflation target emphasize that inflation has many costs and few if any benefits. • Critics of a zero-inflation target claim that moderate inflation imposes only small costs on society, whereas the recession necessary to reduce inflation is quite costly.
  • 36. Copyright © 2004 South-Western Summary • Advocates of reducing the government debt argue that the debt imposes a burden on future generations by raising their taxes and lowering their incomes. • Critics of reducing the government debt argue that the debt is only one small piece of fiscal policy.
  • 37. Copyright © 2004 South-Western Summary • Advocates of tax incentives for saving point out that our society discourages saving in many ways such as taxing income from capital and reducing benefits for those who have accumulated wealth. • Critics of tax incentives argue that many proposed changes to stimulate saving would primarily benefit the wealthy and also might have only a small effect on private saving.