1、,CHAPTER 13,Stabilization Policy,1,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Questions,What principles should guide stabilization policy?What aspects of stabilization policy do economists argue about today?Is monetary policy or fiscal policy more effective as a stabilizati
2、on policy?How does uncertainty affect the way stabilization policy should be made?,2,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Questions,How long are lags associated with stabilization policy?Is it better for stabilization policy to be conducted according to fixed rules or
3、 to be conducted by authorities with substantial discretion?,3,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Government Policy,There are two kinds of government policyfiscal policyshifts the IS curvemonetary policyshifts the LM curveThe government uses policy to stabilize the
4、macroeconomy by minimizing the impact of shocks,4,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Monetary Policy Institutions,Monetary policy in the U.S.is made by the Federal Reserve which is the central bankthe principal policy-making body of the Federal Reserve system is the
5、 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 Companies,Inc.All rights reserved.,Monetary Policy Institutions,The Federal Reserve has a central office and 12 regional officesthe central o
6、ffice is the Board of Governors in Washington,DCthe 12 regional offices are the 12 Federal reserve banks scattered around the U.S.the 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 righ
7、ts reserved.,Figure 13.1-Structure of the FederalReserve System,7,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 13.2-Composition of the Federal Open Market Committee,8,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Monetary Policy Institutions,The
8、FOMC meets approximately once 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 C
9、ompanies,Inc.All rights reserved.,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-market
10、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 Institutions,The Federal Reserve can also alter interest rates in two other waysthe Board of Governors can
11、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.,Fiscal Policy Institutions,Fiscal policy in the U.S.is managed by Congressthe Congress
12、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 budget cycle,12,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights res
13、erved.,Figure 13.4-The Budget Process,13,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Government Expenditures,Mandatory expenditures include spending for Social Security,Medicare,Medicaid,unemployment insurance,and food stampsDiscretionary expenditures must be appropriated ea
14、ch year by Congressthese include defense spending,NASA,highway spending,education spending,and so forth,14,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 13.5-Major Federal Government Expenditures by Category,1960-2000,15,Copyright 2002 by The McGraw-Hill Companies,Inc.A
15、ll rights reserved.,Figure 13.6-Federal Government Discretionary Spending,Excluding Defense(2000),16,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Fiscal Policy Institutions,Because of the way the budget process is set up,making fiscal policy in the U.S.is complicated and time
16、-consumingthe time between when a policy 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.,The History of Economic
17、 Policy,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 govern
18、ment 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,Before the Great Depression,the general belief was that the government could not stabilize the economy and should not try to do so
19、It 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 Economic Policy,Because of the l
20、ow 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,20,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserv
21、ed.,Figure 13.7-The U.S.Phillips Curve(s),1955-1980,21,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The History of Economic Policy,By the end of the 1970s,many economists were convinced that active monetary policy did more harm than goodthey argued that the U.S.would be bette
22、r 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 of advocates of this policy,22,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 13.8-The Velocity of Money before 1
23、980,23,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The Power and Limits 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 th
24、e economy are likely to do more harm than goodsome believe that the appropriate government 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 Stabilization Policy,Even the most activist of ec
25、onomists recognize the limits of stabilization policystabilization 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-
26、Hill Companies,Inc.All rights reserved.,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 wellec
27、onomic models from the past may not be useful in forecasting the future effects of policy,26,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Leading Indicators,The index of leading indicators contains ten componentsThe leading indicator that has been most closely watched is the
28、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.,Figure 13.9-Different Measures of the Money Stock Behave Differently,28,Copyright 2002 by The Mc
29、Graw-Hill Companies,Inc.All rights reserved.,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 changes in the money supply through a process called the money multiplier(),29,Copyright
30、 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,The Money Multiplier,The money multiplier can be affected by the the currency-to-deposits ratio that households and businesses keep and the level of excess reserves held by banks,(curr/dep)=currency-to-deposits ratio(req/dep)=ratio of requi
31、red reserves(exc/dep)=excess reserves-to-deposits,30,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Figure 13.10-Changes in the Currency-to-Deposits Ratio,31,Copyright 2002 by The McGraw-Hill Companies,Inc.All rights reserved.,Long Lags&Variable Effects,Even with reliable forec
32、asts,changes in policy affect the economy with long lags and have variable effectsChanges in interest rates take time 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
33、 by The McGraw-Hill Companies,Inc.All rights reserved.,Monetary vs.Fiscal Policy,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 by The McGraw-Hill Compa
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