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

Wrap-Up
FISCAL POLICY
Automatic stabilizers increase expenditures and reduce taxes automatically as the
economy goes into a recession. They act to reduce the impact of economic shocks on
GDP by stabilizing aggregate expenditures.
The full-employment deficit adjusts for the stage of the business cycle and gives
a measure of what the deficit (or surplus) would be if the economy were at full
employment. It provides a clearer picture of the effects of discretionary fiscal
policy actions.
Monetary Policy
Monetary policy affects the level of nominal interest rates, the money supply, and average
inflation in the economy. Decisions by the Federal Reserve about interest rates
are a major focus of participants in the financial market and of news reports. Speeches
by the chair of the Federal Reserve Board—from 1987 until January 2006, Alan
Greenspan—are closely examined for hints about possible interest rate changes,
and speculation can reach a fever pitch when the Federal Open Market Committee
(FOMC) meets to decide on policy.
Some aspects of monetary policy are similar to automatic stabilizers as they
work to keep the economy more stable. But like fiscal policy, monetary policy has
also been used actively to achieve macroeconomic goals.
We have already mentioned one common behavior of the Fed in our discussion
of the aggregate demand–inflation curve. As inflation increases, the Fed, like other
central banks in major industrialized economies, raises the nominal interest rate.
And the nominal rate is raised enough so that the real interest rate rises. This normal
reaction works exactly as does an automatic stabilizer when the economy expands
above potential and inflation starts to rise. Raising the interest rate curtails aggregate
spending and helps stabilize the economy at its potential. A critical issue in the
design of good monetary policy is determining how large such an increase should
be. The strength of this response to an increase in inflation significantly affects the
slope of the ADI curve.
BEHIND THE ADI CURVE—THE ROLE OF
MONETARY POLICY
When the ADI curve was introduced in Chapter 31, we saw that as inflation increases
in the short run, the Fed seeks to raise the real rate of interest. This increase lowers
aggregate expenditures and equilibrium output. Now it is time to take a closer look
at the role of monetary policy in affecting the shape and position of the ADI curve.
736 ∂ CHAPTER 33 THE ROLE OF MACROECONOMIC POLICY