Macroeconomics Chapter 37 - Six Debates Over Macroeconomics Policy

Front 1

1. Should policymakers try to stabilize the economy?
(Arguments FOR active stabilization)

Back 1

- Left on their own, economies tend to fluctuate.
- Policymakers can 'lean against the wind' (use monetary & fiscal policy to stabilize agg demand, output, and employment)
- A more stable economy benefits everyone

Front 2

1. Should policymakers try to stabilize the economy?
(Arguments AGAINST active stabilization)

Back 2

- Monetary & Fiscal Policy work with long lags, so policy must act in advance of economic changes.
- But the shocks that cause fluctuations are unpredictable, and forecasting is highly imprecise.
- If policy takes effect too late, it will worsen fluctuations.
- So, leave the economy to its own devices.

Front 3

2. Should the government fight recessions with spending hikes or tax cuts?
(Arguments for fighting recessions with SPENDING)

Back 3

- Each $ of gov't spending adds directly to agg demand, but only part of each $ of a tax cut goes to AD because consumers save part of it.
- Since most states must keep balanced budgets, federal spending can prevent laying off of public workers, saving jobs.

Front 4

2. Should the government fight recessions with spending hikes or tax cuts?
(Arguments for fighting recessions with TAX CUTS)

Back 4

- Tax cuts increase households' disposable income and therefore increase consumption spending.
- Tax cuts can increase aggregate demand with incentives (like the investment tax credit)
- Tax cuts can increase aggregate supply by increasing the incentive to work and produce goods and services.
- Rapid spending increases may be wasteful ('bridges to nowhere') and will require future tax increases.

Front 5

3. Should monetary policy be made by rule or discretion?
(Arguments AGAINST discretion)

Back 5

- Allowing central bank's discretion could do great harm if they are incompetent.
- Discretion allows the possibility of abuse (using monetary policy to affect election outcomes).
- Central banks who promise price stability may renege if a recession occurs (time-inconsistency: the discrepancy between actual policy and announced policy)

Front 6

3. Should monetary policy be made by rule or discretion?
(Arguments FOR discretion)

Back 6

- Discretion allows flexibility to react to unforeseen events.
- Political business cycles and time-inconsistency are theoretical possibilities but not that important in practice.
- It is difficult to specify rules precisely and to determine what the best rule would be.

Front 7

4. Should the central bank aim for zero inflation?
(Arguments FOR a zero inflation target)

Back 7

- The costs of inflation can be substantial even for low inflation.
- Achieving zero inflation would have temporary costs (higher unemployment) but permanent benefits.
--> These costs could be reduced if the commitment to zero inflation is credible (reduces the expected inflation rate)

Front 8

4. Should the central bank aim for zero inflation?
(Arguments AGAINST a zero inflation target)

Back 8

- The benefits of moving from moderate to zero inflation are small, but costs are large:
-Est: must sacrifice 5% of a year's GDP for each 1% reduction in inflation
-A disinflation would leave permanent scars: investment falls, lowering the future capital stock
-Workers' skill diminish while unemployed
- Some of inflation's costs could be reduced through more widespread indexation.

Front 9

5. Should the government balance its budget?
(Arguments FOR balancing the budget)

Back 9

- Gov't debt places a burden on future generations.
- Budget deficits crowd out investment, reducing growth and future living standards.
- While deficits may be justified during recessions or wars, the surging peacetime debt of recent decades is unsustainable and detrimental.

Front 10

5. Should the government balance its budget?
(Arguments AGAINST balancing the budget)

Back 10

- The burden of gov't debt is exaggerated; it's only a tiny % of a person's lifetime income.
- Cutting the deficit could do more harm than good:
--> Cutting education would reduce future human capital accumulation and future living standards.
--> Raising taxes reduces incentives to work and save
- Focusing on the deficit diverts attention from other programs that redistribute income across generations (e.g., Social Security)
- Debt/Income ratio more relevant than debt itself

Front 11

6. Should the tax laws be reformed to encourage saving?
(Arguments FOR tax reform to encourage saving)

Back 11

- 'A nation's standard of living depends on its ability to produce goods and services'
- Higher saving provides more funds for capital accumulation, which increases productivity and living standards.
- 'People respond to incentives'
- The current US tax system discourages saving...better to replace income tax with consumption tax to increase the incentive to save.

Front 12

6. Should the tax laws be reformed to encourage saving?
(Arguments AGAINST tax reform to encourage saving)

Back 12

- Such tax reform would mainly benefit the wealthy, who need tax relief the least.
- Estimates of the interest-rate elasticity of saving are low, so tax incentives may not increase saving much.
- Reducing taxes on capital income may increase the gov't budget deficit, negating the benefits of higher private saving
- Better: increase national saving directly by reducing the budget deficit.