Principles of Macroeconomics 3250:201 Richard W. Stratton

The University of Akron Administration 4 graded assignments next week Homework 13, 14 Essay 04 CBT Test 05 (Thursday - Saturday) 9/21/2018 The University of Akron Decision Tree

Policy Debates: Introduction Questions needing consideration To intervene or Not? Are policy rules sufficient or is Discretionary policy necessary? Is the an advantage to either Fiscal or Monetary Policy? What is the Shape of the AS curve? Why does it matter? 9/21/2018 The University of Akron

Policy Debates: Introduction Questions continued Is there an “best” Policy target? Price level or GDP Interest rate or money supply Inflation rate = zero Is social welfare dependent more on inflation or unemployment? 9/21/2018 The University of Akron

Policy Debates: Introduction Questions continued Is Balancing the budget important? To what extent do Tax laws impact saving? 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Review Readings – Chp. 18 Recall - List 3 main ideas in chapter 18 Summarize – In your own words describe the purpose of chapter 18 Question - Write 1 unanswered question you have from chapter 18 Comment – What is your general impression of this chapter? Connect something in this chapter to your life 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

Discretionary or Policy rules depends on the judgment of policy makers and their interpretation of current and forecast events Fixed-rule allows the money supply to grow at a pre-specified rate Feedback rules pre-specify how the policy action responds to changing events Example: M2 to grow at 3% per year Example: Adjust M2 to maintain a constant interest rate of 3% on 6 month government securities 9/21/2018 The University of Akron

Discretionary or Policy rules State of economic knowledge Knowledge of potential GDP Policy lags and forecast horizon Predictability of policies Can we effectively use economic data to determine our current conditions? Can we determine the “Natural rate of UE and thus the potential GDP? Policies take 12 – 18 months to impact the economy. How accurate are forecasts? How predictable are the results of policy actions? Might they contribute to instability? 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

Fiscal or Monetary Policy What are the necessary steps to use discretionary policy? Timely recognition of situation Policy formation Policy implementation Policy impacts the economy 9/21/2018 The University of Akron

Fiscal or Monetary Policy What are the necessary steps to use discretionary policy? Timely recognition of situation Measure current economic conditions Economic forecast Compare with desired conditions 9/21/2018 The University of Akron

Fiscal or Monetary Policy What are the necessary steps to use discretionary policy? Policy formation Formulate direction Choose policy tool Determine magnitude needed 9/21/2018 The University of Akron

Fiscal or Monetary Policy What are the necessary steps to use discretionary policy? Policy implementation Policy impacts the economy Short-run Long-run 9/21/2018 The University of Akron

Fiscal or Monetary Policy Does either Fiscal or Monetary policy have a clear advantage? Timely recognition of situation Policy formation Policy implementation Policy impacts the economy 9/21/2018 The University of Akron

Fiscal or Monetary Policy What influences either Fiscal or Monetary policy’s impact? Fiscal Policy Monetary Policy Elasticity of Md Elasticity of Id Size of government spending multiplier Size of investment multiplier Crowding-out effect 9/21/2018 The University of Akron

Fiscal or Monetary Policy Fiscal or Monetary policy goals Fiscal Policy Monetary Policy Provide public goods Price stability Redistribute income Real GDP stability Stabilize AD Stability of financial system 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Shape of the AS curve Shape of the AS curve If AS is very elastic A given change in AD leads to small change in inflation If AS is very inelastic A given change in AD leads to large change in inflation 9/21/2018 The University of Akron

The University of Akron Shape of the AS curve Shape of the AS curve If AS is very elastic SRAS Increased AD => little inflation 9/21/2018 The University of Akron

The University of Akron Shape of the AS curve Shape of the AS curve If AS is very inelastic SRAS Increased AD => large inflation 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Policy target Selecting the appropriate target Price level Is a zero rate of inflation desirable? Real GDP Interest rate Money supply – monetary base 9/21/2018 The University of Akron

The University of Akron Policy target Selecting Price level as target AD and AS shocks are met with policies to minimize price changes Increase in AS => must increase AD Decrease in AS => must decrease AD Increase in AD => must decrease AD Decrease in AD => must increase AD 9/21/2018 The University of Akron

Policy target – AS shock Selecting Price level as target Price AS AD Real GDP 9/21/2018 The University of Akron

Policy target –AD shock Selecting Price level as target Price AS AD Real GDP 9/21/2018 The University of Akron

The University of Akron Policy target Selecting the Real GDP target AD and AS shocks are met with policies to minimize GDP changes Increase in AS => must decrease AD Decrease in AS => must increase AD Increase in AD => must decrease AD Decrease in AD => must increase AD 9/21/2018 The University of Akron

Policy target – AS shock Selecting real GDP as target Price AS AD Real GDP 9/21/2018 The University of Akron

Policy target –AD shock Selecting real GDP as target Price AS AD Real GDP 9/21/2018 The University of Akron

The University of Akron Policy target Selecting the Interest rate target AD and AS shocks are met with policies to minimize interest rate changes Thus Ms must move in the same direction as Md 9/21/2018 The University of Akron

The University of Akron Policy target Selecting the Interest rate target Increase in AS => increase in real GDP, but a decrease in price level Decrease in AS => decrease in real GDP, but an increase in price level So direction of monetary policy is uncertain 9/21/2018 The University of Akron

The University of Akron Policy target Selecting the Interest rate target Increase in AD => increase in both real GDP and in price level Md => Ms Decrease in AD => decrease in both real GDP and in price level Md => Ms 9/21/2018 The University of Akron

Policy target – AS shock Selecting Interest rate as target Interest rate Ms Md Quantity of Money 9/21/2018 The University of Akron

The University of Akron Policy target Selecting the Money supply target AD and AS shocks are met with policies to minimize Ms changes No matter what AD and AS do, keep Ms constant Or growing a constant rate 9/21/2018 The University of Akron

Policy target – AS shock Selecting Money Supply as target Interest rate Ms Md Quantity of Money 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Balance budget Is balancing the government budget annually desirable? During recession During an expansion 9/21/2018 The University of Akron

The University of Akron Balance budget Is balancing the government budget annually desirable? If not? Can it be balanced over business cycle? Unified budget? 9/21/2018 The University of Akron

The University of Akron Balance budget Is balancing the government budget annually desirable? If not? Can it be balanced over business cycle? Are we talking about the operating budget? Or the Unified budget? Does it matter? 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Tax laws and saving Tax laws and saving Do we need to increase the rate of private saving? If so, can tax policy increase the saving rate? If so, is it the most efficient way to increase the saving rate? 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14

The University of Akron Worksheet 14 - Scenario 1 Scenario 1 Md relatively interest rate elastic Id relatively interest rate inelastic Fed Purchase $75 billion bonds 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Md relatively interest rate elastic Ms0 i Md 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Id relatively interest rate inelastic Id i 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Current situation Ms0 Id i i Md 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Fed Purchase $75 billion bonds Ms0 Ms1 Id i i Md 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Scenario 1 Md relatively interest rate elastic Id relatively interest rate inelastic Fed Purchase $75 billion bonds Relatively little impact on interest rates Relatively little impact on planned investment 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Scenario 1 Md relatively interest rate elastic Id relatively interest rate inelastic Increase federal deficit by $125 billion Decrease taxes Increase spending Some of both 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Increase federal deficit by $125 bil. Increase demand reduces private investment only slightly. Id0 Id1 i SS 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 1 Increase federal deficit by $125 bil. Ms0 Ms1 Id i i Md 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 2 Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity. This is an example of discretionary monetary policy. This is a poor economic policy; it will tend to make business cycle fluctuations greater. 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 2 Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity. This is an example of discretionary monetary policy. False; It is either a feedback rule or a misstatement of a fixed rule. 9/21/2018 The University of Akron

The University of Akron Worksheet 14 - Scenario 2 Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity. This is a poor economic policy; it will tend to make business cycle fluctuations greater. True: This would have expansionary policy during expansions and contractionary policy during contractions. 9/21/2018 The University of Akron

Student Questions Discretion or Rules Fiscal or Monetary AS curve Decision Tree Student Questions Discretion or Rules Fiscal or Monetary AS curve Policy target Balance budget Taxes & saving Worksheet 14