Chapter 15

Chapter 15 - Chapter 15 - Stabilization Policy - Activist...

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Chapter 15 - Stabilization Policy - Activist vs. Nonactivism See opening quote by Robt. Gordon, p. 385. Or another example - you get sick, take medication, but the medication has a three day delay. Driving your car by looking in the rear view mirror. See graphs on page 387 and 389. Economic instability and monetary instability. Possible strong link between these two variables. Widespread agreement about the goals of macro policy: low un, high levels of employment, real output growth, low and stable inflation, etc. The debate in macro is between activist vs. nonactivist (passive) approach to policy. Rules vs. discretion debate. Passive, Rules Approach: fixed money growth, balanced budget amendment, term limits, flat tax, expiration dates on legislation, etc. Maintain stable, predictable fiscal and monetary policy during all phases of the business cycle. Don't attempt countercyclical fine-tuning, it will be destabilizing. Historical consensus, traditional view: Market economy failed in the 30s, self-correcting mechanisms didn't work, government intervention is what finally rescued the economy. Led to the growth in Keynesian economics, dominated the economics profession and strongly influenced policymakers - Congress and presidents. "We're all Keynesians now." In the 50s and 60s, economists and policymakers became confident in the Keynesian approach - activist, stabilization policy, mostly fiscal policy. During a recession: run a budget deficit and have expansionary monetary policy. During an expansion, run a budget surplus and contractionary monetary policy. More faith in the ability of policymakers to smooth economic flucuations than in the self-correcting mechanisms of the market economy. What about the problem with lags? Page 393-395. Recognition lag, policy lag and impact lag. Possible solution to Lags: Forecasting Tools.
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1. Index of Leading Economic Indicators. An index of ten economic variables that as a group tend to move AHEAD of economic conditions, predict economic expansions and contractions. There is also the Indexes of a) coincident indicators (move with the business cycle) and b) lagging indicators (move after the business cycle). Based on historical evidence. See page 390. All eight recessions were predicted by the Index. Also 5 false predictions. Example: housing permits are a leading indicator, a predictor of future housing activity, housing contstruction might be a coincident indicator, and furniture or appliance sales might be a lagging indicator. Some labor market variables (avg workweek in hours, un claims), some wholesale variables (new orders, slower deliveries, plant and equipment order, housing permits), some financial variables (M2, int rate spread, stock prices) and expectations (consumers). The index of leading of leading economic indicators receives the most attention - used as a forecasting tool for where the economy is headed. Can give policymakers a head start to avoid the recognition lag. 2. Forecasting Models
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Chapter 15 - Chapter 15 - Stabilization Policy - Activist...

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