To discuss the arguments for and against active government counter-stabilization policy.
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 Stabilization Policy
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 Fedís 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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Unemployment on the Rise For many years after the Great Depression, the basic
goal of national economic policy was to minimize unemployment. But the winter of 1982 saw 12 million men and women unemployed, and many complained bitterly
that they were the victims of a needlessly cruel government policy. This time public enemy number one was inflation and the jobless workers were the casualties
in the war.
From Richard Nixon through Jimmy Carter, President
after President set out to fight inflation. But when that fight threatened to increase
unemployment, President after President reversed course, opting for stimulative
policies to keep the economy growing and unemployment low.
When the Federal Reserve began once again to tighten the money supply, workers and businessmen alike refused to believe that the
government was serious about ending inflation. Wages and prices continued
upwards, growing faster than the money supply. Finally, as unemployment passed10%, the inflation rate began to drop. In August, Fed Chairman Paul Volcker announced that the time had come to ease monetary policy. Wall Street was the first to respond. But the bitter memories of the recession lingered on
and faith in counter-cyclical policy was one of the casualties. By 1985, after 2 years of recovery, inflation remained at 4%...but the economy still
bore the scars of the recession. Millions of manufacturing jobs were gone for good... and unemployment remained stuck at 7%. Fifteen years of entrenched inflationary expectations had been sharply reduced, but only after the government had finally proven its willingness to pay the price necessary to wring inflation out of the economic system.
Comment and Analysis by Richard Gill One could argue that the difficult times of the early 1980s were really a reflection of the success of our past policies. The very success of these policies, however, undoubtedly contributed to the recent inflationary tendencies of the economy and, perhaps more significantly, to the expectation of future inflation. By 1980, they had created a general sense that the government would back down in the inflation fight as soon as it began