Lecture 19 - Five debates over macroeconomic policy. After reading this chapter, you should be able to answer the following questions: Should monetary and fiscal policymakers try to stabilize the economy? Should monetary policy be made by rule rather than by discretion? Should the central bank aim for zero inflation? Should the government balance its budget? Should the tax laws be reformed to encourage saving? | Review of the previous lecture 1. Three models of aggregate supply in the short run: sticky-wage model imperfect-information model sticky-price model All three models imply that output rises above its natural rate when the price level falls below the expected price level. 2. Phillips curve derived from the SRAS curve states that inflation depends on expected inflation cyclical unemployment supply shocks presents policymakers with a short-run tradeoff between inflation and unemployment 1 Review of the previous lecture 3. How people form expectations of inflation adaptive expectations based on recently observed inflation implies “inertia” rational expectations based on all available information implies that disinflation may be painless 2 Review of the previous lecture 4. The natural rate hypothesis and hysteresis the natural rate hypotheses states that changes in aggregate demand can only affect output and employment in the short run hysteresis states that agg. demand can have permanent | Review of the previous lecture 1. Three models of aggregate supply in the short run: sticky-wage model imperfect-information model sticky-price model All three models imply that output rises above its natural rate when the price level falls below the expected price level. 2. Phillips curve derived from the SRAS curve states that inflation depends on expected inflation cyclical unemployment supply shocks presents policymakers with a short-run tradeoff between inflation and unemployment 1 Review of the previous lecture 3. How people form expectations of inflation adaptive expectations based on recently observed inflation implies “inertia” rational expectations based on all available information implies that disinflation may be painless 2 Review of the previous lecture 4. The natural rate hypothesis and hysteresis the natural rate hypotheses states that changes in aggregate demand can only affect output and employment in the short run hysteresis states that agg. demand can have permanent effects on output and employment 3 Five Debates Over Macroeconomic Policy Instructor: Abbas Lecture 19 Five Debates over Macroeconomic Policy Should monetary and fiscal policymakers try to stabilize the economy? Should monetary policy be made by rule rather than by discretion? Should the central bank aim for zero inflation? Should the government balance its budget? 5. Should the tax laws be reformed to encourage saving? Five Debates over Macroeconomic Policy Debate I Should monetary and fiscal policymakers try to stabilize the economy? Pro: Policymakers should try to stabilize the economy The economy is inherently unstable, and left on its own will fluctuate. Policy can manage aggregate demand in order to offset this inherent instability and reduce the severity of economic fluctuations. There is no reason for society to suffer through the booms and busts of the business cycle. Monetary and fiscal policy can stabilize aggregate demand and, thereby, production and .
