Policy

Question 1

What is the basis of macro economics ?

Answer 1

That governments could take into action to improve economic performance

Question 2

Within policy what are the 3 main points we look at ??

Answer 2

1. Uncertainty and policy
2. Expectations and policy
3. Politics and policy

Question 3

How much would economists know about the future if they were to:

Answer 3

– They should know whether unemployment is at, above, or below the natural level
– They should know whether this is going to cause inflation or not
– By how much will the increase in money supply decrease the interest rate? What will be the effect on long-term rates? Stock prices?
– What is the effect on the currency? The trade balance?

Question 4

How much do macroeconomists actually know ??

Answer 4

They defo do not have all the answers or knowledge required for solving economic problems
They rely on models all of which give different answers on how to solve a particular problem

Question 5

What are 2 schools of thought from economists about policy ??

Answer 5

Milton Friedman said “Because of long and variable lags, activists policy is likely to do more harm than good

Franco Modiglliani said “Economists; knowledge is good enough to allow for increasingly fine-tuning of the economy”

Essentially some economists believe that policy makers should do less and others believe they should do more

Question 6

Should policy makers do less ?

Answer 6

The short answer is yes
-Substantial uncertainty about effects of macroeconomic policies”
-Because of this policy makers should be more careful

Question 7

What should the main goal of policies be ?

Answer 7

They should be broadly aimed at avoiding prolonged recessions, slowing down booms and avoiding inflationary pressure;

The higher the unemployment rate, or the higher the inflation rate, the more active policy should be

Question 8

When should policy makers stop ??

Answer 8

Well short of fine-tuning the economy, trying to achieve constant growth of unemployment or output growth can result in harm done to the economy

Question 9

Why do policy expectations matter ??

Question 10

What is an economic example of why expectations of policy matters

Answer 10

-The link between inflation and employment

Question 11

What is time inconsistency of optimal policy ?

Answer 11

The incentive to deviate from the announced policy, once the other player has made its move

Question 12

What is the relation between inflation and unemployment ?

Answer 12

Question 13

What would happen if:

Answer 13

Question 14

Why is credibility important when it comes to policy ?

Answer 14

Monetary authorities will want to be believed that it will act consistantly with its targets

the Central bank needs to make credible comments and act in accordance to its stated objectives

Question 15

How do you deal with the problem of time inconsistency without totally stripping policy-making power from the central bank ??

Answer 15

1. Making the central bank independent;
2. Give incentives to central banks to take the “long” view;
3. Choose a “conservative” central banker who dislikes inflation.

Question 16

What is the relation between inflation and CB independence across OECD countries

Answer 16

Question 17

W

Question 18

Are the effects of macroeconomic policies certain ??

Answer 18

No they are always uncertain

Question 19

What can we say about policy makers and people in the economy ??

Answer 19

That macroeconomic policy can be thought of as a game between them

Question 20

Issues of time inconsistency means what ?/

Answer 20

-Tight restraints on policy makers
-the solution has larger costs because it prevents the use of all macroeconomic policy altogether

Question 21

So what are better solutions to fix the issue of time constraints ?

Answer 21

Design better institutions that can reduce the problem of time inconsistency while at the same time allowing the use of policy for the stabilisation of output

Question 22

What are the 3 issues in fiscal policy where the government budget constraint plays a role ?

Answer 22

-Ricardian Equivalence
-Deficits, output stabilisation and cyclically adjusted deficit
-Wars and deficits

Question 23

Politics and fiscal restraints are what ?

Answer 23

-Fiscal rules
-Fiscal rules for countries within a monetary union

Question 24

What is the Ricardian Equivalence ?

Answer 24

The proposition that neither deficits or debts have any effect on economic activity once the government budget constraint is taken into account

Question 25

An example of the RE is: Suppose the government raises gov spending, this can either be financed by raising taxes now or by rasing public debt Does how the spending is financed affect economic activity ?

Answer 25

Consumers do not change their consumption in response to a tax cut if the present value of after-tax labour income is unaffected. -The effect of lower taxes today is cancelled out by higher taxes tomorrow. Theory suggests that under certain conditions the timing of taxes does not matter, however, its the present value of tax-liabilities that matters

Question 26

Does RE apply in practice ??

Answer 26

Evidence suggest that we should take this into account however do not take it too seriously and suggest that debts and deficits do not matter at all

Question 27

Why should you not take the RE too seriously ??

Answer 27

1. Tax cuts are known, but future tax rises are uncertain; 2. Individuals are not infinitely lived, or don’t optimise over all future time periods perfectly, so might ignore possibility of future tax increases; 3. Not all households are the same.

Question 28

The fact that budget deficits have adverse effects implies that deficits during recessions should be offset by surpluses during booms, what does this avoid ?

Answer 28

Avoids a steady increase in debt

Question 29

What is full employment deficit ??

Answer 29

The deficit would be, under the existing tax and spending rules, if output were at the natural level of output

Question 30

Cyclically adjusted deficit

Answer 30

The deficit would be, under the existing tax and spending rules, if output were at the natural level of output

Question 31

What happens when actual deficit is larger but the cyclically deficit is 0 ??

Answer 31

Current fiscal policy is consistent with no systematic increase in debt over time The debt will increase as long as output is below its natural level, Once natural level is reached the deficit will go away and debt will stabilise

Question 32

Should cyclically adjusted deficit be at 0 all the time ??

Answer 32

No, as in a recession the gov way want to run a deficit large enough that the CAD is positive However in this case the return of output to its natural level will not be enough to stabilise debt The gov would need to take further measures, from tax increases, to cuts in spending to decrease the deficit, so debt stabilises

Question 33

Why has practice of the cyclically adjusted deficit proven tricky ??

Answer 33

1. Not easy to establish how much lower the deficit would be if output was higher 2. Very difficult to asses how car output is from natural level, if the calculation is wrong than policy will have severe consequences

Question 34

How do you establish how much lower the deficit would be if output was higher ??

Answer 34

-A reliable rule suggests that 1% decrease in output automatically leads to a 0.5% increase in deficit of GDP

Question 35

Why should you run deficits in wars ??

Answer 35

1. Deficit finance is a way to pass some of the burden of war to those alive after war, Seems only fair for future generations to share in the sacrifices the war requires 2. Deficit spending helps reduce tax distortions

Question 36

What happens when the government finance gov spending during wars with Deficit financing ??

Answer 36

-Will lead to a sharp increase in gov spending, which in turn increases demand for goods -Because output is fixed, interest rates will go up -Then investment will decrease sharply

Question 37

What happens when the government finance gov spending during wars with taxation financing ??

Answer 37

An increase in taxation will lower consumption sharply. * By how much, depends upon consumers’ expectations: the longer they expect the war to last, the longer they will expect higher taxes to last, and the more likely they will decrease consumption. * In any case, the increase in government spending will be partly offset by the decrease in consumption, and therefore the increase in the interest rate and decrease in investment will be smaller.