In this session we want to understand:
• arguments for and against discretionary
fiscal and monetary policies
• arguments for policy credibility
Perfect timing and information
Expected
• Problems with discretionary policies:
• lags:
– recognition lag
• Problems with discretionary policies:
• lags:
– recognition lag
– response lag
• decision making
• Problems with discretionary policies:
• lags:
– recognition lag
– response lag
• decision making
• implementation process
• Problems with discretionary policies:
• lags:
– recognition lag
– response lag
• decision making
• implementation process
– transmission lag
Discretionary policies are destabilizing
t1
Discretionary policies are destabilizing
Path of the target variable
t1
Policy tool
Discretionary policies are destabilizing. They
increase their magnitude and longitude.
t1 is the
expected
inflationary
t1
surge
t2
t3
Discretionary policies are destabilizing. They
increase their magnitude and longitude.
t1 is the
expected
inflationary
t1
surge
t2 is when the
policy is
implemented
t2
t3
Discretionary policies are destabilizing. They
increase their magnitude and longitude.
t1 is the
expected
inflationary
t1
surge
t2 is when the
policy is
implemented
t2
t3
t3 is when
the policy
becomes
effective
t4
Discretionary policies are destabilizing. They
increase their magnitude and longitude.
t1 is the
expected
inflationary
t1
surge
t2 is when the
policy becomes
implemented
t2
t3
t3 is when
the policy
becomes
effective
t4
The economy
would have been
out of its cyclical
problem by t4
• Policymakers have more information that
households and firms
• They act in the public interest rather for
profit. This means they try to maximize the
collective welfare.
• Time lags
• Policymakers act based on their own
individual interest rather than public interest
(Public Choice Theory)
• The economy is usually producing below its
potential because of :
– income tax which discourages labor to supply
less than they would otherwise do
• The economy is usually producing below its
potential because of :
– income tax which discourages labor to supply less than they would
otherwise do
– government regulations discourage maximum
production
•
The economy is usually producing below its potential because of :
– income tax which discourages labor to supply less than they would
otherwise do
– government regulations discourage maximum production
• Policy makers must choose between
ultimate goals of achieving capacity output
and inflation (PC). Policymakers are apt to
enact policies that are inflationary (Robert
Barro and David Gordon).