1. Fiscal and Monetary Policy: Debates
Chapter 18

2. Debate 1 Which policy to use? Fiscal or monetary?
Which one is more effective?
Which one has less goal conflicts?
Which one is more flexible?

3. Debate 1 Continued Which one is more effective?
Fiscal policy and monetary policy have different transmission mechanisms
Δ T or ΔG  Δ AE  Δ real GDP (but in sequence, counteracting effects on real GDP through money demand and interest rate)
Δ M Δ interest rate  Δ I  Δ real GDP
Which one is more effective depends on sensitivity of money demand and investment demand.

4. Debate 1 Continued Which one had less goals conflict?
More goals conflict with fiscal policy than with monetary policy because fiscal policy tends to target a specific group while the effect of monetary policy is neutral.
Which one is more flexible
Monetary policy because of less bureaucratic red tapes.

5. Debate 2 Rule vs. discretion in monetary policy Three options
Discretionary monetary policy
Carrying out monetary policy on the basis of the judgment of policy makers
Rule-based (or fixed rule) policy: monetarism
Policy pursued according to a certain rule, independently of the state of economy
Feedback-rule policy: Keynesian activism (e.g. Taylor rule)
Carrying out monetary policy by predetermined feedback rules according to changes in the state of economy.

6. Debate 2 Continued When there is a AD shock, Monetarism
Allow real GDP and the price level to fluctuate and come back to the full employment equilibrium through the natural course.
Keynesian activism
Restore the full-employment equilibrium as quickly as possible.
Despite the apparent superiority of the feedback rule policy, rule-based policy is better because of uncertainty about the target and lags and unpredictability of policies..

7. Debate 2 Continued When there is a supply shock, Monetarism
Allow real GDP and the price level to fluctuate and come back to the full employment equilibrium through the natural course.
Keynesian activism
Restore the full-employment equilibrium as quickly as possible.
The feedback rule policy restores full employment faster, but with higher price level.

8. Debate 3 Should policy target real GDP, the price level or both?
Targeting only one would be extreme.
Stabilizing real GDP only means destabilizing the price level in the face of shocks to AS.
Stabilizing the price level only means destabilizing the real GDP in the face of shocks to AS.
More general targeting would be placing some weight on fluctuations in both real GDP and the price level (probably with more weight on the price level)

9. Debate 3 Continued
If we concentrate on the price level, should the target inflation rate be zero or positive?
Arguments for positive inflation
Because of built-in overstated measurement bias
As product and labor market lubricant
Mild inflation make profit increase and cost reduction, so more labor employment
Some economists do not buy this idea.