PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 15 Rules versus Discretion in Macroeconomic Policy

Copyright © 2004 South-Western. All rights reserved.15–2 Fundamental Issues 1.What are policy time lags, and how might they cause well-meaning macroeconomic policymakers to destabilize the economy? 2.What are the main arguments favoring discretionary policymaking? 3.Why is policy credibility a crucial factor in maintaining low inflation? 4.How might monetary policy credibility be achieved?

Copyright © 2004 South-Western. All rights reserved.15–3 Fundamental Issues 4.How might monetary policy credibility be achieved? 5.How might fiscal policy credibility be achieved? 6.What approaches have some nations with fixed exchange rates followed to make their policies credible?

Copyright © 2004 South-Western. All rights reserved.15–4 Figure 15–1 How Policy Time Lags Can Make Well-Intentioned Policy Destabilizing

Copyright © 2004 South-Western. All rights reserved.15–5 Figure 15–2 Output-Market Equilibrium and Policy Goals

Copyright © 2004 South-Western. All rights reserved.15–6 Figure 15–3 Potential and Equilibrium Outcomes of a Macroeconomic Policy Game

Copyright © 2004 South-Western. All rights reserved.15–7 Figure 15–4 The Inflation Bias of Discretionary Policymaking

Copyright © 2004 South-Western. All rights reserved.15–8 Figure 15–5 Complete Wage Indexation and Discretionary Monetary Policy

Copyright © 2004 South-Western. All rights reserved.15–9 Sources: Economic Report of the President, 2002; Economic Indicators (various issues). Figure 15–6 Annual Inflation Rates in the United States

Copyright © 2004 South-Western. All rights reserved.15–10 Source: Alberto Alesina and Lawrence Summers, “Central Bank Independence and Macroeconomic Performance,” Journal of Money, Credit, and Banking (May 1993): 151–162. Figure 15–7a Central Bank Independence and Average Inflation Key: AUS:AustriaNET:Netherlands BEL:BelgiumNZ:New Zealand CAN:CanadaNOR:Norway DEN:DenmarkSPA:Spain FRA:FranceSWE:Sweden GER:GermanySWI:Switzerland ITA:ItalyUK:United Kingdom JAP:JapanUSA:United States

Copyright © 2004 South-Western. All rights reserved.15–11 Figure 15–7b Central Bank Independence and Inflation Variability Key: AUS:AustriaNET:Netherlands BEL:BelgiumNZ:New Zealand CAN:CanadaNOR:Norway DEN:DenmarkSPA:Spain FRA:FranceSWE:Sweden GER:GermanySWI:Switzerland ITA:ItalyUK:United Kingdom JAP:JapanUSA:United States Source: Alberto Alesina and Lawrence Summers, “Central Bank Independence and Macroeconomic Performance,” Journal of Money, Credit, and Banking (May 1993): 151–162.

Copyright © 2004 South-Western. All rights reserved.15–12 Figure 15–8a Central Bank Independence and Output Volatility Source: Carl Walsh, “Output-Inflation Tradeoffs and Central Bank Independence,” Federal Reserve Bank of San Francisco Weekly Letter, No , September 22, 1995; Carl Walsh, “Is There a Cost to Having an Independent Central Bank?” Federal Reserve Bank of San Francisco Weekly Letter, No , February 4, 1994.

Copyright © 2004 South-Western. All rights reserved.15–13 Source: Carl Walsh, “Output-Inflation Tradeoffs and Central Bank Independence,” Federal Reserve Bank of San Francisco Weekly Letter, No , September 22, 1995; Carl Walsh, “Is There a Cost to Having an Independent Central Bank?” Federal Reserve Bank of San Francisco Weekly Letter, No , February 4, Figure 15–8b Central Bank Independence and the Inflation-Output Trade-off