Overview
Purpose:
To discuss the arguments for and against active government counter-stabilization policy.
Objectives:
1. Classical economists believe that there is little that the government can do to reduce unemployment and increase GNP growth, especially in the long run. They maintain that in the long run fiscal stimulus raises interest rates and monetary stimulus raises prices without affecting real growth.
2. Expectations may reduce the effectiveness of government stabilization policies.
a) expectations that the government will reverse an anti-inflation policy will keep the policy from being effective
b) "rational expectations" may keep a stimulative policy from lowering unemployment because individuals and firms may simply demand higher wages and prices.
3. It is difficult to determine exactly what monetary policy to pursue because neither interest rates nor the money supply are perfect indicators of the restrictiveness of monetary policy.
4. Government fiscal policy has often been complicated by political problems, and large structural deficits make it even more difficult to use discretionary fiscal policies.
| Key Economic Concepts Classical perspective, rational expectations, credibility of government policies, constant growth rate rule, interest rates vs. money supply, structural deficits, inside and outside policy lags. |
| Contemporary Issues During the 1990s, the Fed moved toward a more activist monetary policy, pushing up interest rates to cool down the economy (in 1994 and 2000), and pushing down interest rates to counter financial, economic and geopolitical shocks (in 1998 and 2001). The long boom of the 1990s and the shallow recession of 2001 might suggest that the Fed’s attempts at fine-tuning have been successful. However, how much of this was due to luck and other developments, such as the technology boom, and how much to adept policies? |
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