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1、,CHAPTER 13,Stabilization Policy,1,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,CHAPTER 13Stabilization Policy,Questions,What principles should guide stabilization policy?What aspects of stabilization policy do economists argue about today?Is monetary policy or fiscal polic
2、y more effective as a stabilization policy?How does uncertainty affect the way stabilization policy should be made?,2,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,QuestionsWhat principles shoul,Questions,How long are lags associated with stabilization policy?Is it better fo
3、r stabilization policy to be conducted according to fixed rules or to be conducted by authorities with substantial discretion?,3,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,QuestionsHow long are lags ass,Government Policy,There are two kinds of government policyfiscal poli
4、cyshifts the IS curvemonetary policyshifts the LM curveThe government uses policy to stabilize the macroeconomy by minimizing the impact of shocks,4,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Government PolicyThere are two,Monetary Policy Institutions,Monetary policy in t
5、he U.S. is made by the Federal Reserve which is the central bankthe principal policy-making body of the Federal Reserve system is the Federal Open Market Committee (FOMC)the FOMC lowers and raises interest rates and increases and decreases the money supply,5,Copyright 2002 by The McGraw-Hill Compani
6、es, Inc. All rights reserved.,Monetary Policy InstitutionsMo,Monetary Policy Institutions,The Federal Reserve has a central office and 12 regional officesthe central office is the Board of Governors in Washington, DCthe 12 regional offices are the 12 Federal reserve banks scattered around the U.S.th
7、e members of the Board of Governors and the Presidents of the regional Federal Reserve Banks make up the FOMC,6,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy InstitutionsTh,Figure 13.1 - Structure of the FederalReserve System,7,Copyright 2002 by The McGraw-Hi
8、ll Companies, Inc. All rights reserved.,Figure 13.1 - Structure of the,Figure 13.2 - Composition of the Federal Open Market Committee,8,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.2 - Composition of t,Monetary Policy Institutions,The FOMC meets approximately once
9、 a month to set interest ratesemergency meetings can also be scheduled on short noticeWhen the FOMC decides on a policy change, it is implemented immediatelyit takes only minutes for interest rates to shift in response to FOMC actions,9,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights re
10、served.,Monetary Policy InstitutionsTh,Monetary Policy Institutions,The FOMC changes interest rates by carrying out open-market operationsin an expansionary open-market operation, the Federal Reserve buys government bonds, increasing bank reserves, and lowering interest ratesin a contractionary open
11、-market operation, the Federal Reserve sells government bonds, decreasing bank reserves, and raising interest rates,10,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy InstitutionsTh,Monetary Policy Institutions,The Federal Reserve can also alter interest rates
12、in two other waysthe Board of Governors can alter legally required bank reservesthe Board of Governors can lend money directly to financial institutionsThese tools are used very rarely,11,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary Policy InstitutionsTh,Fiscal Pol
13、icy Institutions,Fiscal policy in the U.S. is managed by Congressthe Congress creates the tax laws that determine the amount of taxes imposed by the federal governmentthe Congresss spending bills determine the level of government purchasesTax and spending levels are set through a process called the
14、budget cycle,12,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Fiscal Policy InstitutionsFisc,Figure 13.4 - The Budget Process,13,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.4 - The Budget Proce,Government Expenditures,Mandatory expenditur
15、es include spending for Social Security, Medicare, Medicaid, unemployment insurance, and food stampsDiscretionary expenditures must be appropriated each year by Congressthese include defense spending, NASA, highway spending, education spending, and so forth,14,Copyright 2002 by The McGraw-Hill Compa
16、nies, Inc. All rights reserved.,Government ExpendituresMandato,Figure 13.5 - Major Federal Government Expenditures by Category, 1960-2000,15,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.5 - Major Federal Go,Figure 13.6 - Federal Government Discretionary Spending,
17、Excluding Defense (2000),16,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.6 - Federal Governme,Fiscal Policy Institutions,Because of the way the budget process is set up, making fiscal policy in the U.S. is complicated and time-consumingthe time between when a poli
18、cy proposal is made and when it becomes effective (the inside lag) can take yearsthe inside lag associated with monetary policy changes can be measured in days or weeks,17,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Fiscal Policy InstitutionsBeca,The History of Economic Po
19、licy,The Employment Act of 1946established Congresss Joint Economic Committee and the Presidents Council of Economic Advisorscalled on the President to estimate and forecast the current and future level of economic activity in the U.S.announced that it was the responsibility of the federal governmen
20、t to foster and promote free enterprise and the general welfare,18,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The History of Economic Policy,The History of Economic Policy,Before the Great Depression, the general belief was that the government could not stabilize the econ
21、omy and should not try to do soIt was largely due to the writings of John Maynard Keynes that economists and politicians became convinced that governments could halt depressions and smooth out the business cycle,19,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The History of
22、 Economic Policy,The History of Economic Policy,Because of the low and stable inflation and unemployment rates of the 1960s, economists and politicians thought that the business cycle was deadHowever, in the 1970s, expected inflation rose and the Phillips curve shifted upthe result was stagflation,2
23、0,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The History of Economic Policy,Figure 13.7 - The U.S. Phillips Curve(s), 1955-1980,21,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.7 - The U.S. Phillip,The History of Economic Policy,By the e
24、nd of the 1970s, many economists were convinced that active monetary policy did more harm than goodthey argued that the U.S. would be better off with an “automatic” monetary policy one idea is to fix the money stock to a stable long-run growth paththe instability of velocity has reduced the number o
25、f advocates of this policy,22,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The History of Economic Policy,Figure 13.8 - The Velocity of Money before 1980,23,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.8 - The Velocity of,The Power and Li
26、mits of Stabilization Policy,Economists today have varied views as to how the central bank and fiscal authorities should manage the economysome (such as Milton Friedman) feel that activist attempts to manage the economy are likely to do more harm than goodsome believe that the appropriate government
27、 policy can do a lot to stabilize the economy after shocks occur,24,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Power and Limits of Stabil,The Power and Limits of Stabilization Policy,Even the most activist of economists recognize the limits of stabilization policystab
28、ilization policy requires us to know where the economy is and where it is goinguse large-scale macroeconomic models to forecast the futuresearch for leading indicatorsthe level of the stock market is often used,25,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Power and L
29、imits of Stabil,The Lucas Critique,Expectations of the future affect decision-making in the presentRobert Lucas argued that, because expectations of the future include expectations of government policies, if policies are changed the structure of the economy may change as welleconomic models from the
30、 past may not be useful in forecasting the future effects of policy,26,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Lucas CritiqueExpectations,Leading Indicators,The index of leading indicators contains ten componentsThe leading indicator that has been most closely watc
31、hed is the money supplythere are four measures of the money supply (M1, M2, M3, and L)these four monetary aggregates do not behave in the same way,27,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Leading IndicatorsThe index of,Figure 13.9 - Different Measures of the Money St
32、ock Behave Differently,28,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.9 - Different Measur,The Money Multiplier,Open market operations change the monetary basethe effects on the money supply are less direct and less certainChanges in the monetary base cause chang
33、es in the money supply through a process called the money multiplier (),29,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Money MultiplierOpen marke,The Money Multiplier,The money multiplier can be affected by the the currency-to-deposits ratio that households and busines
34、ses keep and the level of excess reserves held by banks,(curr/dep)=currency-to-deposits ratio(req/dep)=ratio of required reserves(exc/dep)=excess reserves-to-deposits,30,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,The Money MultiplierThe money,Figure 13.10 - Changes in the
35、 Currency-to-Deposits Ratio,31,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.10 - Changes in the,Long Lags & Variable Effects,Even with reliable forecasts, changes in policy affect the economy with long lags and have variable effectsChanges in interest rates take t
36、ime to affect investment, aggregate demand, and real GDPThe level of GDP today is determined by what long-run risky interest rates existed more than a year and a half ago,32,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Long Lags & Variable EffectsEv,Monetary vs. Fiscal Poli
37、cy,At the end of the World War II era, most economists and policy makers believed that the principal stabilization policy tool would be fiscal policyToday, the overwhelming consensus is that monetary policy has proven itself to be faster acting and more reliable than fiscal policy,33,Copyright 2002
38、by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary vs. Fiscal PolicyAt t,Monetary vs. Fiscal Policy,Fiscal policy takes a longer amount of time to workdelays due to the political processThis means that the Federal Reserve can neutralize the effects of any change in fiscal policy on agg
39、regate demandswings in tax laws and appropriations have little effect on real GDP unless the Federal Reserve wishes them to,34,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Monetary vs. Fiscal PolicyFisc,Automatic Stabilizers,Automatic stabilizers include tax collections and
40、 social transfer programs such as food stamps and unemployment insuranceThese work without new policies having to be created and therefore can moderate the business cycle much more quickly than can discretionary policy,35,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Automat
41、ic StabilizersAutomatic,How Monetary Policy Works,Monetary policy takes time to work as wellthe Federal Open Market Committee must first recognize that there is a problem and then formulate a policywhile changes in interest rates will occur almost immediately, it takes over a year for changes in int
42、erest rates to change national output and unemployment,36,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,How Monetary Policy WorksMonet,How Monetary Policy Works,The Federal Reserve can either target real interest rates or keep the money stock growing smoothlyif the principal
43、 instability in the economy is a shifting IS curve, targeting interest rates will not stabilize the economyif the instability in the economy occurs because money demand is unstable or because the currency-to-deposits and the reserves-to-deposits ratios vary, then targeting interest rates is wiser,37
44、,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,How Monetary Policy WorksThe F,Rules vs. Authorities,Should monetary policy be conducted “automatically” according to rules or should it be left to the discretion of authorities?the first reason for automatic rules is that we fe
45、ar that the people appointed to authorities will be incompetentthe second reason for fixed rules is that authorities might not have the right objectivespolitical business cycle,38,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Rules vs. AuthoritiesShould mo,Figure 13.11 - The
46、 Politically-Influenced Business Cycle: Relative Growth in the Second Year of Presidential Terms,39,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.11 - The Politically,Central Bank Independence,Research has suggested that the more independent a central bank, the bet
47、ter its performancemore independent central banks presided over lower average inflation and less variable inflationcountries with independent banks did not have higher unemployment rates, lower real GDP growth, or larger business cycles,40,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights
48、 reserved.,Central Bank IndependenceResea,Figure 13.12 - Inflation and Central Bank Insulation from Politics,41,Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.,Figure 13.12 - Inflation and C,Credibility & Commitment,In the short run, pursuing a more expansionary monetary polic
49、y can seem to have great benefitshigher real GDP, lower unemployment, little impact on inflationIn the long run, however, a central bank is wiser to keep low inflation as its top prioritykeeps expected inflation low and maintains credibility,42,Copyright 2002 by The McGraw-Hill Companies, Inc. All r
50、ights reserved.,Credibility & CommitmentIn the,Credibility & Commitment,Economists call this conflict between short-run and long-run interests dynamic inconsistencysome economists have argued that this is another reason to have a fixed set of rules for monetary policyothers believe that central bank
