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Five Debates over Macroeconomic Policy

1. 2. 3. 4. 5. Shouldmonetaryandfiscal policymakerstry to stabilizethe economy? Shouldmonetarypolicybe madeby rule ratherthanby discretion? Shouldthe central bankaimfor zero inflation? Shouldthe governmentbalanceits budget? Shouldthe tax lawsbe reformedto encouragesaving?

1. Shouldmonetaryandfiscal policymakerstry to stabilizethe economy? Pro: Policymakers should try to stabilize the economy
The economyis inherentlyunstable,and left on its ownwill fluctuate. Policycan manageaggregatedemandin orderto offset this inherentinstabilityand reducethe severityof economicfluctuations. Thereis no reasonfor societyto sufferthroughthe boomsand bustsof the businesscycle. Monetaryand fiscal policycan stabilizeaggregatedemandand, thereby,productionand employment.

Con: Policymakers should not try to stabilize the economy

Monetarypolicyaffectsthe economywith longand unpredictablelagsbetweenthe needto act and the timethat it takesfor thesepoliciesto work. Manystudiesindicatethat changesin monetarypolicyhavelittle effect on aggregatedemanduntil aboutsix monthsafter the changeis made. Fiscalpolicyworkswith a lag becauseof the longpolitical processthat governschangesin spendingand taxes. It can take yearsto propose,pass, and implementa majorchangein fiscal policy. All too oftenpolicymakerscan inadvertentlyexacerbateratherthanmitigatethe magnitudeof economicfluctuations. It mightbe desirableif policymakerscouldeliminateall economicfluctuations,but this is not a realisticgoal.

2. Shouldmonetarypolicybe madeby rule ratherthanby discretion? Pro: Monetary policy should be made by rule
Discretionarymonetarypolicycan sufferfromincompetenceand abuseof power.

To the extentthat central bankersally themselveswith politicians,discretionarypolicycan lead to economicfluctuationsthat reflectthe electoralcalendarthe political businesscycle. Theremaybe a discrepancybetweenwhatpolicymakerssay theywill do and whattheyactuallydo calledtimeinconsistencyof policy. Becausepolicymakersare so oftentimeinconsistent,peopleare skepticalwhencentral bankers announcetheir intentionsto reducethe rate of inflation. Committingthe Fed to a moderateand steadygrowthof the moneysupplywouldlimit incompetence,abuseof power,and timeinconsistency.

Con: Monetary policy should not be made by rule

An importantadvantageof discretionarymonetarypolicyis its flexibility. Inflexiblepolicieswill limit the ability of policymakersto respondto changingeconomic circumstances. The allegedproblemswith discretionand abuseof powerare largelyhypothetical. Also,the importanceof the political businesscycleis far fromclear. 3.

Shouldthe centralbankaimfor zero inflation?

Pro: The central bank should aim for zero inflation

Inflationconfersno benefit to society,but it imposesseveralreal costs.
Shoeleather costs Menu costs Increased variability of relative prices Unintended changes in tax liabilities Confusion and inconvenience Arbitrary redistribution of wealth

Reducinginflationis a policywith temporarycostsand permanentbenefits. Oncethe disinflationaryrecessionis over, the benefitsof zero inflationwouldpersist.

Con: The central bank should not aim for zero inflation
Zeroinflationis probablyunattainable,and to get thereinvolvesoutput, unemployment,and social coststhat are too high. Policymakerscan reducemanyof the costsof inflationwithoutactuallyreducinginflation.


Shouldfiscal policymakersreducethe governmentdebt?

Pro: The government should balance its budget

Budgetdeficitsimposean unjustifiableburdenon futuregenerationsby raisingtheir taxesand loweringtheir incomes. Whenthe debtsandaccumulatedinterestcomedue, futuretaxpayerswill facea difficult choice:
They can pay higher taxes, enjoy less government spending, or both.

By shiftingthe cost of currentgovernmentbenefitsto futuregenerations,thereis a bias against futuretaxpayers. Deficitsreducenationalsaving,leadingto a smallerstockof capital, whichreducesproductivity andgrowth.

Con: The government should not balance its budget

The problemwith the deficit is oftenexaggerated. The transferof debt to the futuremaybe justifiedbecausesomegovernmentpurchasesproduce benefitswell into the future. The governmentdebt can continueto rise becausepopulationgrowthandtechnologicalprogress increasethe nation s ability to pay the intereston the debt. 5.

Shouldthe tax lawsbe reformedto encouragesaving?

Pro: Tax laws should be reformed to encourage saving

A nationssavingrate is a key determinantof its long-run economicprosperity. A nationsproductivecapabilityis determinedlargelyby howmuchit savesand investsfor the future. Whenthe savingrate is higher,moreresourcesare availablefor investmentin newplant and equipment. The U.S. tax systemdiscouragessavingin manyways,suchas by heavilytaxingthe incomefrom capital and by reducingbenefitsfor thosewhohaveaccumulatedwealth. The consequencesof highcapital incometax policiesare reducedsaving,reducedcapital accumulation,lowerlaborproductivity,and reducedeconomicgrowth. An alternativeto currenttax policiesadvocatedby manyeconomistsis a consumptiontax. Witha consumptiontax, a householdpaystaxesbasedon whatit spendsnot on whatit earns.
Income that is saved is exempt from taxation until the saving is later withdrawn and spent on consumption goods.

Con: Tax laws should not be reformed to encourage saving

Manyof the changesin tax lawsto stimulatesavingwouldprimarilybenefit 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.

Reducingthe tax burdenon the wealthywouldleadto a less egalitariansociety. This wouldalso forcethe governmentto raisethe tax burdenon the poor. Raisingpublicsavingby eliminatingthe government s budgetdeficit wouldprovidea moredirect andequitablewayto increasenationalsaving.

Advocatesof activemonetaryandfiscal policyviewthe economyas inherentlyunstableand believepolicycan be usedto offsetthis inherentinstability. Criticsof activepolicyemphasizethat policyaffectsthe economywith a lag and our ability to forecastfutureeconomicconditionsis poor, both of whichcan leadto policybeing destabilizing. Advocatesof rulesfor monetarypolicyarguethat discretionarypolicycan suffer from incompetence,abuseof power,and timeinconsistency. Criticsof rulesfor monetarypolicyarguethat discretionarypolicyis moreflexiblein respondingto economiccircumstances. Advocatesof a zero-inflationtargetemphasizethat inflationhas manycostsand few if any benefits. Criticsof a zero-inflationtarget claimthat moderateinflationimposesonlysmall costson society, whereasthe recessionnecessaryto reduceinflationis quite costly. Advocatesof reducingthe governmentdebt arguethat the debt imposesa burdenon future generationsby raisingtheir taxesand loweringtheir incomes. Criticsof reducingthe governmentdebt arguethat the debt is only onesmall pieceof fiscal policy. Advocatesof tax incentivesfor savingpoint out that our societydiscouragessavingin manyways suchas taxingincomefromcapital andreducingbenefitsfor thosewhohaveaccumulated wealth. Criticsof tax incentivesarguethat manyproposedchangesto stimulatesavingwouldprimarily benefit the wealthyand alsomighthaveonly a small effect on privatesaving.