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

many economists—should governments even attempt to intervene to stabilize the
macroeconomy? Or do such attempts simply worsen economic performance?
THE NONINTERVENTIONIST PERSPECTIVE
Those who share the view that government should not intervene to stabilize the
economy differ in their reasons. Some believe that the economy is efficient, leaving
little for the government to add. Others believe that government actions are ineffective,
while still others argue that they do have significant effects but often simply
make matters worse. We now take a closer look at each of these perspectives.
Real Business Cycle Theory:Intervention Is Unnecessary Intervention
is clearly unnecessary if the economy always operates efficiently at full employment.
Real business cycle theorists, led by Ed Prescott of the Arizona State University,
attribute the economy’s fluctuations to external shocks, such as the 1973 and 1979 oil
price increases, or to shifts in the economy’s underlying productivity, as may have
occurred in the late 1990s. More importantly, these theorists believe that markets
adjust quickly—prices and wages are sufficiently flexible that full employment will
be rapidly restored—and certainly in less time than it would take for government to
recognize a problem, act, and have an effect. According to real business cycle theorists,
the fluctuations we observe are not signs that output is deviating from potential;
instead, they argue that potential GDP fluctuates, with wages and prices adjusting
to ensure that all markets clear.
Since the economy is at full employment, government need worry only about
keeping inflation low and stable. The central bank just needs to set a low target for
inflation and ensure that it is achieved.
New Classical Macroeconomics: Intervention Is Ineffective Some
noninterventionists, while not claiming that all fluctuations are efficient, still argue
that the government cannot affect output even in the short run. If the government
attempts to expand the economy, shifting the aggregate demand–inflation (ADI)
curve to the right, all market participants recognize that higher inflation will result.
So price- and wage-setting behavior and expectations adjust immediately in anticipation
of the higher inflation, and the short-run inflation adjustment (SRIA) curve
shifts up, leaving the economy with higher inflation and no expansion in real output.
The new classical view also argues that inflation can be reduced without leading
to higher unemployment. By reducing its inflation target, the monetary authority
shifts the ADI curve to the right. If market participants are convinced that the inflation
target has been reduced, they will immediately adjust their wage and price
behavior, and lower inflation is achieved at no cost.
The new classical economists, led by Robert Lucas of the University of Chicago,
strongly advance the view that predictable and systematic macroeconomic policies
are largely ineffective in influencing real output and employment.
Intervention Is Counterproductive Some noninterventionists accept
that government policies can affect the economy, and they may see shortcomings
844 ∂ CHAPTER 38 CONTROVERSIES IN MACROECONOMIC POLICY