[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

THE NEW TRADE-OFF:
OUTPUT STABILITY–INFLATION STABILITY
In recent years, economists such as John Taylor of Stanford University have argued
that attempts to stabilize fluctuations in output and employment will cause inflation
to fluctuate more. And attempts to stabilize fluctuations in inflation will cause
output and employment to fluctuate more. 1 Thus policymakers face a different tradeoff:
one between fluctuations in the real economy (output and unemployment) and
fluctuations in inflation. One important aspect of this shift in focus is that it encourages
the use of macro policies to stabilize the economy rather than attempting to
achieve unsustainable outcomes (such as an average unemployment rate below the
natural rate). Later in this chapter we will see how the trade-off between stability in
output and in inflation is affected by the policy rule followed by the central bank.
So far, our discussion has concentrated on the trade-offs that policymakers face.
But even when they agree about the objectives, they may disagree about how best
to achieve those objectives. Should fiscal policy be the main tool for stabilizing the
economy? Or should monetary policy take the lead?
Fiscal Policy
Fiscal policy is defined as changes in government expenditures and taxes that are
designed to achieve macroeconomic policy goals. In earlier chapters, we learned
about the consequences of changes in fiscal policy. The full-employment model is
useful for assessing the impact of budget deficits and surpluses on the real interest
rate, investment, and growth. The model of short-run fluctuations in Chapter 31
provides a framework for analyzing how unemployment and inflation would be
affected by swings in fiscal policy that shifted the aggregate demand–inflation (ADI)
curve. These models offer insights into the effects of fiscal policy, but we now need
to use those insights to focus on how fiscal policy can contribute to the macroeconomic
goals of full employment, low and stable inflation, and economic growth. We
will start by distinguishing between two types of policies—automatic stabilizers and
discretionary actions.
AUTOMATIC STABILIZERS
One way that fiscal policy contributes to macroeconomic goals is by instituting automatic
stabilizers. Automatic stabilizers are expenditures that automatically increase,
or taxes that automatically decrease, when economic conditions worsen. We have
1 John B. Taylor, “How Should Monetary Policy Respond to Shocks While Maintaining Long-Run Price Stability?—
Conceptual Issues,” in Achieving Price Stability: A Symposium (Kansas City, Mo.: Federal Reserve Bank of Kansas
City, 1996), pp. 181–95.
FISCAL POLICY ∂ 729