551-15 - Chapter 15 STABILIZATION OUTPUT AND EMPLOYMENT See opening quote by Robert Gordon p 327 We now consider the debate in macroeconomics about

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See opening quote by Robert. Gordon, p. 327. We now consider the debate in macroeconomics about whether macro policy (monetary and fiscal) can be used to effectively stabilize the economic fluctuations of the business cycle. The debate centers around two different views of policy: activist (Keynesian "fine tuning") vs. nonactivist (passive, rules based policy advocated by Classical school). Sometimes the debate is referred to as "rules vs. discretion." Rules = passive approach, Discretion = active approach. Graph on page 328, Exhibit 1, shows the record of economic instability. What, if anything, can macro policy do to stabilize and smooth out the economic fluctuations, smooth out the business cycle? There is widespread agreement about the goals of macro policy: low un, high levels of employment, strong output growth, low and stable inflation, etc. The great debate in macro is between the activist strategy vs. nonactivist (passive) strategy - which strategy will more effectively achieve the economic goals stated above and promote a strong economy? Activist Strategy: Keynesian, activist, "fine-tuning," contercyclical approach to stabilize the economy. Based on the belief that the self-correcting mechanisms (Classical assumptions) work slowly, and policymakers should continually "fine-tune" the economy through an activist approach to policy. Passive Strategy: Classical approach, assumes that the self-correcting mechanisms will work well, if not stifled by unnecessary meddling by policymakers. In fact, advocates of the passive approach believe that erratic, improperly timed activist policies are actually a source of economic instability, and that we would be better off if we maintain stable, predictable fiscal and monetary policy during all phases of the business cycle. Advocates of the passive approach point to the Great Depression as an example of how perverse monetary and fiscal policy can significantly destabilize the economy, and claim that improper policy turned an ordinary recession into a ten year depression. See pages 340-341. We know that the proper policy during a recession is expansionary fiscal and/or monetary policy. However, the Fed implemented restrictive monetary policy (contracted the money supply) and Congress implemented restrictive fiscal policy by raising taxes and tariffs. THE CONDUCT OF ACTIVIST POLICY To stabilize the economy, policymakers have to correctly time policy so that they stimulate an economy moving into a recession and slow down an economy heading toward inflationary overheating. If the timing of policy is not precise, active policy will actually destabilize the economy and make it worse. In that case, it would be like a doctor making an ailing patient even sicker by giving them the wrong medicine! What tools are available to potentially help activist policymakers achieve proper timing? MGT 551: BUSINESS ECONOMICS CH – 15
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This note was uploaded on 01/23/2012 for the course FIN 551 taught by Professor Staff during the Spring '11 term at University of Michigan.

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551-15 - Chapter 15 STABILIZATION OUTPUT AND EMPLOYMENT See opening quote by Robert Gordon p 327 We now consider the debate in macroeconomics about

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