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

investment, they can have different longer-run effects on the economy. A monetary
expansion lowers real interest rates, stimulating investment. In contrast, a fiscal
expansion reduces national saving and results in a higher real interest rate and
lower investment. Using fiscal policy to stimulate the economy, by reducing private
investment, may have harmful effects on future potential output.
Fiscal and monetary policies differ as well in their impact on exports and imports.
A monetary expansion that lowers interest rates will also tend to cause the currency
to depreciate as foreign investors seek higher returns elsewhere. 7 A depreciation
decreases imports (by making foreign goods more expensive) and increases
exports. In contrast, a fiscal expansion that causes interest rates to rise also causes
the currency to appreciate; net exports fall as foreign goods become less expensive.
In recent decades, monetary policy has been the chief tool for macroeconomic
stabilization policies, and discretionary fiscal policy has played little role in the
United States. The chief reason, as already noted, is the lags inherent in the fiscal
policy process—particularly the inside lag, or time needed to implement the necessary
expenditure or tax changes. First, it takes time to recognize the need to stimulate
or restrain aggregate spending. Data are subject to revision, and conflicting
developments often can frustrate attempts to determine the true condition of the economy.
For example, after the 2001 recession, one survey of households tended to indicate
strong employment growth even as a survey of firms showed continued job
losses. Then, after some change in the economy is recognized, there is the delay due
to the time it takes to design a package of new tax or spending initiatives (whether
increases or cuts) and get it approved by Congress. While the delay in recognizing
changed economic conditions is the same whatever the approach, the inside lag is
much longer for fiscal than for monetary policy. Postwar recessions have lasted less
than a year on average. By the time—often longer than a year—a tax bill is approved
by Congress, the economy is entering a different phase of the business cycle. A policy
that makes sense when it is introduced may easily turn out to be inappropriate when
it comes into effect. This unwieldiness limits the effectiveness of discretionary fiscal
policy. In contrast, the FOMC meets every six weeks, and, if conditions warrant,
committee members can hold telephone conferences more frequently. Hence,
monetary policy can act swiftly to deal with new economic developments.
Monetary and fiscal policies also differ in the speed with which a policy action
affects the economy. Monetary policy stimulates the economy by lowering interest
rates, thereby increasing investment in equipment and housing and increasing net
exports. Even after firms see a decrease in the real interest rate, it may take some
time before they commit to new investment, and before the capital goods industry
starts producing the newly ordered goods. Similarly, though in the long run a lower
real interest rate leads to increased demand for housing, it takes a while before plans
are drawn up, permits are obtained, and construction starts. Typically, six months
or longer must pass before monetary policy’s effects on output are realized. By contrast,
increased government purchases have a direct and immediate effect on total
spending. The time required for the change in policy to affect the economy is called
the outside lag, and it is normally shorter for fiscal policy. Wrap-Up
7 The reason that interest rate changes affect the exchange rate is discussed in Chapter 35.
750 ∂ CHAPTER 33 THE ROLE OF MACROECONOMIC POLICY