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1、17-1,17-2,17,Policy,Item Item Item Etc.,17-3,Introduction,In this chapter we examine how policymakers formulate appropriate policy measures Must consider: Timing Uncertainty How individuals will respond to specific policies Role of credibility Monetary or fiscal policy, or a mix Different policy ins
2、truments Different intermediate and ultimate targets,17-4,Lags in the Effects of Policy,Suppose the economy is at full employment: Affected by a negative aggregate demand disturbance reduces the equilibrium level of income below full employment No advance warning of disturbance no policy action take
3、n in anticipation of its occurrence Policymakers must decide: Should they respond to the disturbance? If so, how should they respond?,17-5,Lags in the Effects of Policy,Is the disturbance permanent (or persistent) or temporary? Figure 17-1 illustrates a temporary aggregate demand shock A one period
4、reduction in consumption best policy is to do nothing at all Todays policy actions take time to have an effect would hit economy after back at full-employment level, driving it away from the optimal level,Insert Figure 17-1 here,17-6,Lags in the Effects of Policy,Policymaking is a process: Takes tim
5、e to recognize and implement a policy action Takes time for an action to work its way through the economy Each step involves delays or lags: Inside lags Recognition lags Decision lags Action lags Outside lags,Inside Lags: the time period it takes to undertake a policy action Recognition Lag: the per
6、iod that elapses between the time a disturbance occurs and the time the policymakers recognize that action is required Lag is negative if the disturbance is predicted and appropriate policy actions considered before it occurs (Ex. Increase money supply prior Christmas) Lag is typically positive,17-7
7、,Lags in the Effects of Policy,Policymaking is a process: Takes time to recognize and implement a policy action Takes time for an action to work its way through the economy Each step involves delays or lags: Inside lags Recognition lags Decision lags Action lags Outside lags,Inside Lags: the time pe
8、riod it takes to undertake a policy action Decision Lag: the delay between the recognition of the need for action and the policy decision Differs between monetary and fiscal policy FOMC meets regularly to discuss and decide on policy,17-8,Lags in the Effects of Policy,Policymaking is a process: Take
9、s time to recognize and implement a policy action Takes time for an action to work its way through the economy Each step involves delays or lags: Inside lags Recognition lags Decision lags Action lags Outside lags,Inside Lags: the time period it takes to undertake a policy action Action Lag: the lag
10、 between the policy decision and its implementation Also differs for monetary and fiscal policy Monetary policy makers typically act immediately Fiscal policy actions are less rapid administration must prepare legislation and then get it approved,17-9,Lags in the Effects of Policy,Policymaking is a
11、process: Takes time to recognize and implement a policy action Takes time for an action to work its way through the economy Each step involves delays or lags: Inside lags Recognition lags Decision lags Action lags Outside lags,Outside Lags: time it takes a policy measure to work its way through the
12、economy Inside lags are discrete, but outside lags are typically distributed lags Once a policy action has been taken, its effects on the economy are spread out over time Immediate impacts may be small, but other effects occur later,17-10,Lags in the Effects of Policy,Figure 17-2 illustrates the dyn
13、amic multiplier Shows the effects of a once-and-for-all 1 percent increase in the money supply in period zero Impact is initially very small, but continues to increase over a long period of time Why are there outside lags? Monetary policy: initially impacts investment via interest rates, not income
14、When AD ultimately affected, increase in spending itself produces a series of induced adjustments in output and spending,Insert Figure 17-2 here,17-11,Monetary Versus Fiscal Policy Lags,Fiscal policy directly impacts aggregate demand Affect income more rapidly than monetary policy Shorter outside la
15、gs than monetary policy Longer inside lags than monetary policy Long inside lags makes fiscal policy less useful for stabilization and used less frequently to stabilize the economy,It takes time to set the policies in action, and then the policies themselves take time to affect the economy. Further
16、difficulties arise because policymakers cannot be certain about the size and the timing of the effects of policy actions.,17-12,Expectations and Reactions,Government uncertainties about the effects of policies on the economy arise because: Policymakers do not know what expectations firms and consume
17、rs have Government does not know the true model of the economy Work with econometric models of the economy in estimating the effects of policy changes An econometric model is a statistical description of the economy, or some part of it,17-13,Reaction Uncertainties,Suppose the government decides to c
18、ut taxes to stimulate a weak economy temporary tax cut How big of a cut is needed? One possibility: temporary tax cut will not affect long-term income, and thus not long-term spending Large tax cut needed Alternatively: consumers may believe tax cut will last longer than announced, and MPC out of ta
19、x cut is larger Smaller tax cut might be sufficient,If the government is wrong about consumers reactions, it could destabilize rather than stabilize the economy.,17-14,Uncertainty and Economic Policy,Policymakers can go wrong in using active stabilization policy due to: Uncertainty about the expecta
20、tions of firms and consumers Difficulties in forecasting disturbances Lack of knowledge about the true structure of the economy Uncertainty about the correct model of the economy Uncertainty about the precise values of the parameters within a given model of the economy,Instead of choosing between fi
21、scal and monetary policies when the multipliers are unknown, best to employ a portfolio of policy instruments. DIVERSIFICATION,17-15,Targets, Instruments, and Indicators,Economic variables play a variety of roles in policy discussions Useful to divide them into targets, instruments, and indicators T
22、argets: identified goals of policy Ultimate targets Ex. “to achieve zero inflation” Intermediate targets Ex. Targeting money growth Used to achieve ultimate target,17-16,Targets, Instruments, and Indicators,Economic variables play a variety of roles in policy discussions Useful to divide them into t
23、argets, instruments, and indicators Instruments: tools policymakers manipulate directly Ex. An exchange rate target Indicators: economic variables that signal us as to whether we are getting closer to our desired targets Ex. Increases in interest rates (indicator) sometimes signal that the market an
24、ticipates increased future inflation (target) Provide useful feedback policymakers can use to adjust the instruments in order to do a better job of hitting targets,17-17,Rules Versus Discretion,In determining how policymakers should operate, policymakers must answer several questions: Should policym
25、akers actively try to offset shocks? If yes: Should responses be precommitted to specific rules? OR Should policy makers work on a case-by-case basis?,17-18,Rules Versus Discretion,Milton Friedman and others argued: There should be no use of active countercyclical monetary policy Monetary policy sho
26、uld be confined to making the money supply grow at a constant rate Friedman advocated a simple monetary rule Fed does not respond to the condition of the economy Policies that respond to the current or predicted state of the economy = activist policies/discretionary policies Debate over whether fiscal and monetary authorities should follow rules or execute discretionary policy Activist rules are possible as well,