Chapter 18. Stabilization Policy
Plus pages 435-36 on the Taylor Rule
Chapter 18. Stabilization Policy
+ pages 435-36 Taylor Rule
Homework page 538 1, 3a-c
Skip appendix
H.W. p. 538 #1, 3a-c
Link to syllabus
General discussion of activist vs. passive policy. Contrasts
McChesney Martin and Milton Friedman.
(McChesney Martin didn’t take away the punch bowl)
Full Employment Act of 1946 was key step in inserting Keynes.
Keynesian legacy. Countercyclical policy can help. Fiscal more
important than monetary.
Old issues: Monetary or fiscal? What was source of instability? IS
or LM; what is best indicator of policy tool (i or M, real
nominal, which version of G or T)? What is Ybar, or UN?
Slow or fast?
Criticism of intervention: Lags in implementation—inside lag
(perception, action) and outside lags—impact. Mentions long
and variable lags. Also notes existence of automatic stabilizers,
such as unemployment benefits.
Economic forecasting done by leading indicators, then by models.
Moreover, note mistakes in forecasting.
Review Theory:
Recall Fig. 14-2, p. 405. Shifts in AD and Short Run Fluctuations
The big issue is how
quickly the AS shifts
left from AS1 to AS2.
Rational Expectations
theorists say it happens
very quickly, thus
countercyclical policy
won’t change output
nor employment much.
Recall Fig. 14-2, p. 405. Shifts in AD and
Short Run Fluctuations
2
Fig. 10-12, 10-13, pp. 292, 295. Changes in
AD
Rational expectations school argues that if government policy causes
a change in AD, and that is known, there will be an immediate
shift in SRAS, and so Y (output; therefore employment/unemployment)
will not change. In other words, countercyclical policy is no good.
Fig. 14-1, p. 384. Forecasting the Recession of 1982
Milton Friedman, 1912-2006
Monetarism
Consumption function
(Introduced expectations into macro)
Flexible exchange rates
Monetary Growth rule
Leader of anti-government movement
Link to Friedman’s homepage
Figs. 9-12, 13, pp. 292, 295. Changes in
AD
Rational expectations school argues that
if government policy causes
a change in AD, and that is known, there
will be an immediate shift in SRAS, and
so Y (output; therefor employment/
unemployment) will not change. In other
words, countercyclical policy is no good.
Fig. 18-1, p. 525. Forecasting the
Recession of 1982.
Missed the start, missed the end.
(predictions are averages of 20
models, reported by NBER)
Friedman’s contributions:
Monetarism
Consumption function
Introduced expectations
Floating exchange rates
Monetary growth rule
Anti-government
Rational expectations theory is major criticism of intervention. The
only policy effect that has an impact on AD is a surprise.
Suggestion of a “paradigm shift.” (Copernicus, Darwin)
Lucas critique of models, and of estimates of the sacrifice ratio.
(Someplace in here Mankiw mentions Christina Romer)
3
Robert Lucas
Born 1937 in state of Washington
Parents were leftist, blue collar,
working class.
Undergraduate major in history at
U. of Chicago, where he has spent
most of his academic career.
Nobel Prize in 1995, primarily for
work in Rational Expectations.
Thomas Sargent
Born 1943 in Pasadena, California.
B.A. at UC-Berkeley, Ph.D. Harvard, 1968
Nobel Prize, 2011 for his work in Rational
Expectations (and related areas)
Rational Expectations:
Expectations are forward looking and
adjust quickly,
Only surprises affect the economy
Rules and credibility are better than
discretionary
Criticism of econometric models that
don’t capture expectations. Time
Consistency. Game theory.
Thomas Sargent
Also worked on rational expectations.
Taught at Penn, Minnesota, Stanford, and is now at NYU.
Describes himself as a Democrat, “a fiscally conservative, socially
liberal Democrat,” adding, “I think that budget constraints are really
central.”
It’s important to consider the “incentive effects” of government
policies, he continued. “There are trade-offs in efficiency and equality,
and they lead to choices that aren’t easy,” he said. [NY Times]
Robert Barro, 1944Undergrad at CalTech in physics, Ph.D. from
Harvard. Taught for several years at Chicago,
and now is at Harvard. Ex-columnist for Business
Week.
Known as proponent of “Ricardian Equivalence,”
positing that government deficit spending will
not increase aggregate demand, as people
will reduce current spending to save up for eventual repayment of the
government debt. Not surprisingly, he is harshly critical of Keynesian
countercyclical policies.
Robert Barro.
Also part of the Chicago School.
Ricardian Equivalence (mentioned in
Chapter 19 pp. 554 ff)
Has recently switched to the study of the economics of religion and
culture on the macroeconomy.
Rules vs. discretion.
Balanced budget (Gramm-Rudman; Fiscal Cliff)
Money growth rate
Monetary growth rate –Friedman and monetarists.
Monetary
Growth Rule i
Monetary Growth Rule ii
4
Bernanke’s testimony 11/16/05
In his first extended public appearance since President Bush nominated
him to lead the Fed, Mr. Bernanke stoutly defended his proposal to base
monetary policy on an explicit target for inflation and asserted that he
would not weaken the central bank's "dual mandate" of promoting full
employment as well as stable prices.
And in describing his approach, he sharply distanced it from those of
some central banks that focus almost exclusively on an inflation
target and not at all on promoting growth. "I don't agree with that,"
Mr. Bernanke declared flatly
When confronted with passages from a textbook he had written, in
which he asserted that budget deficits tend to push up interest rates
and "crowd out" private investments, he conceded that "it's possible"
that tax cuts could cause more problems than they solve.
Zero inflation
Article on Bernanke supporting shift
to zero inflation
Some countries (New Zealand, U.K., and European Central Bank)
have shifted to inflation targeting.
Other Rules:
Targets for interest rates, exchange rates, stock market.
Taylor’s rule: p.435. Funds rate = π + 0.5(π - 2.0) + 0.5(Y - Ybar)
Figure 14-1, p. 416. Federal Funds Rate: Actual and
Suggested
Figure 15-1, p. 436. Federal Funds
Rate: Actual and Suggested
Taylor Rule, p. 415: Fed. Funds rate = π + 0.5(π - 2.0) – 0.5 (Y - Ybar)
Other comments:
Fine tuning may have negative supply side impacts
Traditional distrust of politicians—political business cycle
Real world needs some discretion—Greenspan.
Fig. 14-3, p. 398. Inflation and Central Bank
Fig. 18-2, p. 535. Inflation and Central
Independence
Bank Independence