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Chapter 22 Five Debates Over
Macroeconomic Policy
• Should Monetary and Fiscal Policymakers try to
stabilize the economy?
• Should Monetary Policy be Made by an
Independent Central Bank?
• Should the central bank aim for zero inflation?
• Should Fiscal Policymakers reduce the
Government Debt?
• Should the tax laws be reformed to encourage
saving?
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Debate 1
Monetary and Fiscal Policy-makers should try to Stabilize
the Economy:
PRO:
• The economy is inherently unstable, and if left unchecked,
the economy will go through long and frequent periods of
recession and high unemployment.
• With careful timing and proper actions, policy-makers can
use monetary and fiscal stimulation to prevent recessions or
at least minimize their severity.
• 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 employment.
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Monetary and Fiscal Policy-makers should try to Stabilize
the Economy:
CON:
• Discretionary monetary policy affects the economy with
long and unpredictable lags between the “need to act” and
the time that it takes for these policies to exert an influence
of output and employment.
• Many studies indicate that changes in monetary policy have
little effect on aggregate demand until about six months
after the change is made.
• Fiscal policy works with a lag because of the long political
process that governs changes in spending and taxes.
• More often than not these policy initiatives will aggravate
rather than reduce the ups and downs of the economy. 3
Debate 2
Monetary Policy Should Be Made By An Independent
Central Bank:
PRO:
• To the extent politicians influence monetary policy,
economic fluctuations may come to reflect the electorial
calendar - political business cycle.
• There is a time inconsistency of policy - the discrepancy
between announcements (which policy-makers say they are
going to do) and actions (what they subsequently in fact do).
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Monetary Policy Should Be Made By An Independent
Central Bank:
CON:
• Empowering central banks with complete independence in
conducting monetary policy is a problem since it does not
limit incompetence and abuse of power.
• Since changes in aggregate demand translate into changes in
employment and income, it is important that someone be
accountable for monetary policy changes.
• Despite clear and forceful statements by the B of C, it is not
obvious that enhancing the credibility of inflation targets
has resulted in reducing the short-run cost of achieving
lower inflation.
• Elected policy-makers might find fiscal policy more useful
than monetary policy when trying to influence votes.
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Debate 3
The Central Bank Should Aim for Zero Inflation:
PRO:
• Inflation confers no benefit to society, but it does impose
several social costs.
• Reducing inflation is a policy with temporary costs and
permanent benefits. Once the disinflationary recession is
over, the benefits of zero inflation would persist.
• At least six costs of inflation are identified as:
1 . Shoeleather costs
2 . Menu Costs
3 . Increased variability of relative prices
4 . Tax liabilities
5 . Confusion and inconvenience
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6 . Arbitrary redistribution of wealth
Debate 3
The Central Bank Should Aim for Zero Inflation:
CON:
• Zero inflation is probably unattainable and getting there
involves output and unemployment costs that are too high.
• The stimulative effect of a little inflation is necessary to
keep unemployment reasonably low.
• The imperfections of measuring price levels result in
uncertainty about measuring the successful attainment of
zero inflation.
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Debate 4
Fiscal Policymakers should reduce the Government Debt
PRO:
• Budget deficits impose an unjustifiable burden on future
generations by raising their taxes and lowering their
incomes.
• When the debts and accumulated interest come due, future
taxpayers will face a difficult choice:
– They can pay higher taxes, enjoy less government
spending or both.
• By shifting the cost of current government benefits to future
generations, there is a bias toward too large a public sector.
• Deficits reduce national saving, thereby retarding capital
formation, causing lower productivity, and limiting real
growth.
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Debate 4
Fiscal Policymakers should reduce the Government Debt
CON:
• The deficit is only one small part of fiscal policy. The
problem with the deficit is often exaggerated.
• Intergenerational transfers may be justified and some
government purchases produce benefits well into the future
(i.e. reducing budget deficit by cutting spending on
education).
• A balanced budget requirement would limit the policy
options available to deal with emergencies and future
economic crises.
• The government debt can continue to rise. Population
growth and technological progress increases the nation’s
ability to pay the interest on the debt.
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• The budget deficit can be sustained annually, at 5 percent of
the total government debt, or $28 billion.
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Debate 5
The tax laws should be reformed to encourage saving?
“A nation’s productive capability is determined largely by how
much it saves and invests for the future.”
PRO:
• “A nation’s saving rate is a key determinate of its long-run
economic prosperity.”
• When the saving rate is higher, more resources are available
for investment in new plant and equipment.
• “Our society discourages saving in too many ways, such as
by taxing the income from capital heavily and by reducing
benefits for those who have accumulated wealth and
capital.”
• The consequences of high interest income tax policies are:
reduced saving, reduced interest accumulation, lower labour
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productivity, and reduced economic growth.
• An alternative to current tax policies, advocated by many
economists is a consumption tax like the GST.
– A person pays taxes only on the basis of what they
consume (spend) not on what they produce. Income that
is saved is exempt from taxation until the saving is later
withdrawn and spent on consumption goods.
CON:
• Most of the proposed changes in the tax policies to
stimulate saving would benefit primarily the wealthy at the
expense of lower income groups.
• High-income households save a higher fraction of their
income than low-income households. Any tax change that
favors people who save will also tend to favor people with
high income.
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• Reforms would be either regressive or would further the
inequality of income in our society.
• Raising public saving by eliminating the government’s
budget deficit would provide a more direct and equitable
way to increase national saving.
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