U Monetary and Fiscal Policy-makers should try to Stabilize the Economy. u Monetary Policy should be...
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Monetary and Fiscal Policy-makers should try to Stabilize the Economy. Monetary Policy should be made by an Independent Central Bank. The Central Bank should aim for Zero Inflation. The Government should Reduce its Debt. The Tax Laws should be Reformed to Encourage Saving. CH 17
U Monetary and Fiscal Policy-makers should try to Stabilize the Economy. u Monetary Policy should be made by an Independent Central Bank. u The Central
u Monetary and Fiscal Policy-makers should try to Stabilize the
Economy. u Monetary Policy should be made by an Independent Central
Bank. u The Central Bank should aim for Zero Inflation. u The
Government should Reduce its Debt. u The Tax Laws should be
Reformed to Encourage Saving. CH 17
Slide 2
EXAM Same format as December Monday April 18---9AM---Field
House This week-chapter 17 Last class Tuesday April 5Review
+discuss exam Office hours after term ends: April 11: 3-4:30 and
April 13 and April 14 from 9:30-11
Slide 3
US housing-spending down
Slide 4
Monetary and Fiscal Policy-makers should try to Stabilize the
Economy: PRO The economy is inherently unstable, and if left
unchecked, the economy will go through long and frequent periods of
recession and high unemployment. With careful timing and proper
actions, policy-makers can use monetary and fiscal stimulation to
prevent recessions or at least minimize their severity.
Slide 5
Slide 6
Monetary and Fiscal Policy-makers should try to Stabilize the
Economy: PRO 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.
Slide 7
Monetary and Fiscal Policy- CON Discretionary monetary policy
affects the economy with long and unpredictable (variable) lags
between the need to act and the time that it takes for these
policies to exert an influence of output and employment. Many
studies indicate that changes in monetary policy have little effect
on aggregate demand until about six months after the change is
made.
Slide 8
Monetary and Fiscal Policy-makers should try to Stabilize the
Economy: CON Fiscal policy works with a lag because of the long
political process to change spending and taxes. All too often these
policy initiatives can aggravate rather than reduce the ups and
downs of the economy. It might be desirable if policy makers could
eliminate all economic fluctuations, but this is not a realistic
goal. Instead provide stable environment.
Slide 9
Policy question Would you be more likely to support active
stabilization policy if wages, prices, and expectations adjust
quickly in response to economic changes, or if they adjust
slowly?
Slide 10
Refers to AD and AS adjustments If wages, prices, and
expectations adjust slowly, it will take longer for the economy to
return to its natural rates of output and employment. In that case,
theres a better chance that expansionary policy will act in time to
alleviate the recession, rather than push the economy into an
inflationary boom.
Slide 11
Expectations Adjust From SRAS, Y deviates from Y N when P
deviates from P E. Y = YN +a(P-PE) YN =Natural rate of output P is
actual price level PE is expected price level Related to SRPC
Slide 12
US CBO estimate
Slide 13
GREAT DEPRESSION 1929-1933 Real GDP declined 30% Urate
increased from 2.9% to >20% Almost no 2 income families K
causes: Uncertainty, C, I (AD) decline M causes bad mpMS down
Global: international tariff war.
Slide 14
Monetary Policy Should Be Made By An Independent Central Bank:
PRO To the extent politicians influence monetary policy, economic
fluctuations may come to reflect the electoral calendar - political
business cycle. That is, politicians may be tempted to use monetary
policy to affect election results. (SR vs LR objectives).
Slide 15
PRO Independence There is a time inconsistency of policy - the
discrepancy between what policy-makers say they will do what they
subsequently in fact do. This may make people sceptical about
inflation policyslows adjustment of PE to P. Independent BOC has
less incentive tio do this.
Slide 16
PRO Keep monetary policy independent of politics. Evidence
across countries suggests that countries with the most independent
central banks have the lowest inflation rates.
Slide 17
Monetary Policy Should Be Made By An Independent Central Bank:
CON Empowering central banks with complete independence in
conducting monetary policy is a problem since it does not limit
incompetence and abuse of power. Changes in aggregate demand
translate into changes in employment and income, so someone should
be accountable for monetary policy changes.
Slide 18
Monetary Policy Should Be Made By An Independent Central Bank:
CON Despite clear and forceful statements by the B of C, it is not
obvious that enhancing the credibility of inflation targets has
resulted in reducing the short-run cost of achieving lower
inflation. Elected policy-makers might find fiscal policy more
useful than monetary policy when trying to influence votes.
Slide 19
Independent bank : CON Elected officials are more accountable.
The practical importance of time inconsistency has not been shown.
Question is how much independence.
Slide 20
Bank of Canada How independent?? US Fed is similar. Current
bank-related issues in US have drawn Fed (Bernanke) more into the
political system. Usual central bank goal is price stability.
Slide 21
Obsessing?
Slide 22
Previously quite stable
Slide 23
The Central Bank Should Aim for Zero Inflation: PRO Inflation
confers no benefit to society, but it does impose several social
costs. If inflation is bad, why not 0? Reducing inflation is a
policy with temporary costs and permanent benefits. Once the
disinflationary recession is over, the benefits of zero inflation
would persist.
Slide 24
The Costs of Inflation At least six costs of inflation are
identified as: 1. Shoeleather costs 2. Menu Costs 3. Increased
variability of relative prices 4. Tax liabilities 5. Confusion and
inconvenience 6. Arbitrary redistribution of wealth
Slide 25
Aim for Zero Inflation: NO Zero inflation is probably
unattainable and getting there involves output and unemployment
costs that are too high. The stimulative effect of a little
inflation is necessary to keep unemployment reasonably low. The
imperfections of measuring price levels result in uncertainty about
measuring the successful attainment of zero inflation.
Slide 26
INFLATION COSTS Not all inflations are the same. Little
inflation becomes hyperinflation only with political instability.
5% inflation>>>P doubles in 14 years. Inflation
variability more costly: 3% per year for five years (15 total)
versus 5,0,5,0,5 (15 total)
Slide 27
Measuring inflation ch 6 CPIfixed market basket:3 biases
Substitution biasbuy less of things that go up more in price but
basket is fixed. New products-greater utility from variety
Unmeasured quality changereal price lower. Computing power
Slide 28
Government Debt Should Be Reduced: PRO 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.
Slide 29
The Government Should Balance Its Budget: PRO By shifting the
cost of current government benefits to future generations, there is
a bias toward too large a public sector. Deficits reduce national
saving, thereby retarding capital formation, causing lower
productivity, and limiting real growth. Series of deficits leads to
debt.
Slide 30
Budget deficit reduces S
Slide 31
The Government Should Balance Its Budget: CON The deficit is
only one small part of fiscal policy. The problem with the deficit
and debt is often exaggerated. Intergenerational transfers may be
justified and some government purchases produce benefits well into
the future (i.e. reducing budget deficit by cutting spending on
education).
Slide 32
The Government Should Balance Its Budget: CON A balanced budget
requirement would limit the policy options available to deal with
emergencies and future economic crises. The government debt can
continue to rise. Population growth and technological progress
increase the nations ability to pay the interest on the debt.
Slide 33
Key is debt/GDP
Slide 34
The Tax Laws Should Be Reformed To Encourage Saving A nations
productive capability is determined largely by how much it saves
and invests for the future. S = Y-C-G (simple closed economy) Farm
exampleeat corn vs seed
Slide 35
The Tax Laws Should Be Reformed To Encourage Saving: PRO A
nations saving rate is a key determinate of its long-run economic
prosperity. When the saving rate is higher, more resources are
available for investment in new plant and equipment.
Slide 36
Tax Laws Should Encourage Saving: PRO Our society discourages
saving in too many ways, such as by taxing the income from capital
heavily and by reducing benefits for those who have accumulated
wealth and capital. The consequences of high interest income tax
policies are: reduced saving, reduced interest accumulation, lower
labour productivity, and reduced economic growth.
Slide 37
Reform Tax Laws To Encourage Saving: PRO An alternative to
current tax policies, advocated by many economists is a consumption
tax like the GST-HST. A person pays taxes only on the basis of what
they consume (spend) not on what they produce (earn). Income that
is saved is exempt from taxation until the saving is later
withdrawn and spent on consumption goods.
Slide 38
Tax Laws Should Encourage Saving: CON Most of the proposed
changes in the tax policies to stimulate saving would benefit
primarily the wealthy at the expense of lower income groups.
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 income.
Slide 39
Taxes US: Top 1% of taxpayers pay 37% of taxes Top 10% pay 68%
($100K and more) Top 50% pay 97% of all taxes Tax cuts must be on
those who pay.
Slide 40
Tax Laws Should Encourage Saving: CON Reforms would be either
regressive or would further the inequality of income in our
society. Raising public saving by eliminating the governments
budget deficit would provide a more direct and equitable way to
increase national saving.
Slide 41
Summary-17 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.
Slide 42
Summary-17 Advocates of an independent central bank argue that
such independence guards against politicians using monetary policy
to try to influence voters. A lower rate of inflation and a more
favourable short-run tradeoff between inflation and unemployment is
possible. Critics of an independent central bank argue that because
it has large and lasting influences on aggregate demand, output,
and employment, citizens should have a say on monetary policy
Slide 43
Summary-17 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.
Slide 44
Summary-17 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.
Slide 45
Summary-17 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.
(Elasticity issue)