1. In this session we want to understand: arguments for and against discretionary fiscal and monetary policies arguments for policy credibility

2. Perfect timing and information Policy tool Real GDP Expected Contractionary policy action Actual

3. Problems with discretionary policies: lags: –recognition lag

4. Problems with discretionary policies: lags: –recognition lag –response lag decision making

5. Problems with discretionary policies: lags: –recognition lag –response lag decision making implementation process

6. Problems with discretionary policies: lags: –recognition lag –response lag decision making implementation process –transmission lag

7. Discretionary policies are destabilizing t1t1

8. t1t1 Policy tool Path of the target variable

9. Discretionary policies are destabilizing. They increase their magnitude and longitude. t1t1 t2t2 t 1 is the expected inflationary surge t3t3

10. Discretionary policies are destabilizing. They increase their magnitude and longitude. t1t1 t2t2 t 1 is the expected inflationary surge t 2 is when the policy is implemented t3t3

11. Discretionary policies are destabilizing. They increase their magnitude and longitude. t1t1 t2t2 t 1 is the expected inflationary surge t 2 is when the policy is implemented t3t3 t 3 is when the policy becomes effective t4t4

12. Discretionary policies are destabilizing. They increase their magnitude and longitude. t1t1 t2t2 t 1 is the expected inflationary surge t 2 is when the policy becomes implemented t3t3 t 3 is when the policy becomes effective t4t4 The economy would have been out of its cyclical problem by t 4

13. Policymakers have more information that households and firms They act in the public interest rather for profit. This means they try to maximize the collective welfare.

14. Time lags Policymakers act based on their own individual interest rather than public interest (Public Choice Theory)

15. The economy is usually producing below its potential because of : –income tax which discourages labor to supply less than they would otherwise do

16. The economy is usually producing below its potential because of : –income tax which discourages labor to supply less than they would otherwise do –government regulations discourage maximum production

17. The economy is usually producing below its potential because of : –income tax which discourages labor to supply less than they would otherwise do –government regulations discourage maximum production Policy makers must choose between ultimate goals of achieving capacity output and inflation (PC). Policymakers are apt to enact policies that are inflationary (Robert Barro and David Gordon).