PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved.

Chapter 15Rules versus

Discretionin

Macroeconomic Policy

Copyright © 2004 South-Western. All rights reserved. 15–2

Fundamental Issues

1. What are policy time lags, and how might they cause well-meaning macroeconomic policymakers to destabilize the economy?

2. What are the main arguments favoring discretionary policymaking?

3. Why is policy credibility a crucial factor in maintaining low inflation?

4. How might monetary policy credibility be achieved?

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Fundamental Issues

4. How might monetary policy credibility be achieved?

5. How might fiscal policy credibility be achieved?

6. What approaches have some nations with fixed exchange rates followed to make their policies credible?

Copyright © 2004 South-Western. All rights reserved. 15–4 Figure 15–1

How Policy Time Lags Can Make Well-Intentioned Policy Destabilizing

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Output-Market Equilibrium and Policy Goals

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Potential and Equilibrium Outcomes of a Macroeconomic Policy Game

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The Inflation Bias of Discretionary Policymaking

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Complete Wage Indexation and Discretionary Monetary Policy

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Sources: Economic Report of the President, 2002; Economic Indicators (various issues). Figure 15–6

Annual Inflation Rates in the United States

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Source: Alberto Alesina and Lawrence Summers, “Central Bank Independence and Macroeconomic Performance,” Journal of Money, Credit, and Banking (May 1993): 151–162. Figure 15–7a

Central Bank Independence and Average Inflation

Key:AUS: Austria NET: NetherlandsBEL: Belgium NZ: New ZealandCAN: Canada NOR: NorwayDEN: Denmark SPA: SpainFRA: France SWE: SwedenGER: Germany SWI: SwitzerlandITA: Italy UK: United KingdomJAP: Japan USA: United States

Copyright © 2004 South-Western. All rights reserved. 15–11 Figure 15–7b

Central Bank Independence and Inflation Variability

Key:AUS: Austria NET: NetherlandsBEL: Belgium NZ: New ZealandCAN: Canada NOR: NorwayDEN: Denmark SPA: SpainFRA: France SWE: SwedenGER: Germany SWI: SwitzerlandITA: Italy UK: United KingdomJAP: Japan USA: United States

Source: Alberto Alesina and Lawrence Summers, “Central Bank Independence and Macroeconomic Performance,” Journal of Money, Credit, and Banking (May 1993): 151–162.

Copyright © 2004 South-Western. All rights reserved. 15–12 Figure 15–8a

Central Bank Independence and

Output Volatility

Source: Carl Walsh, “Output-Inflation Tradeoffs and Central Bank Independence,” Federal Reserve Bank of San Francisco Weekly Letter, No. 95-31, September 22, 1995; Carl Walsh, “Is There a Cost to Having an Independent Central Bank?” Federal Reserve Bank of San Francisco Weekly Letter, No. 94-05, February 4, 1994.

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Source: Carl Walsh, “Output-Inflation Tradeoffs and Central Bank Independence,” Federal Reserve Bank of San Francisco Weekly Letter, No. 95-31, September 22, 1995; Carl Walsh, “Is There a Cost to Having an Independent Central Bank?” Federal Reserve Bank of San Francisco Weekly Letter, No. 94-05, February 4, 1994. Figure 15–8b

Central Bank Independence and the Inflation-Output

Trade-off