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

Thinking Like an Economist
TRADE-OFFS AND CHOICES
When economists analyze the decisions of individual households
making consumption purchases, they focus on two
aspects. First, what are the choices available to a given household?
These are defined by the household’s income and the
prices of the different goods it could purchase. With limited
income, buying more of one thing means buying less of something
else—the household faces trade-offs. Second, what are
the preferences of the household? Faced with the same possibilities,
different individuals will make different choices
because they vary in what they like to do or consume.
Economists use this same perspective to analyze actions
by economic policymakers. First, they focus on the trade-offs.
In the case of cyclical unemployment and inflation, they ask
what the short-run trade-offs are—if unemployment is reduced
slightly, how much will inflation rise over, say, the next year?
And they need to understand the long-run trade-offs. Will the
reduction in unemployment be only temporary? Once the policymakers
understand the trade-offs, they can assess the costs
and benefits of the different options and decide on the actual
policies they want to implement. A policymaker who believes
inflation is very costly will make different choices than one
who sees its costs as less significant. Even if they agree about
the way the economy behaves, differences in preferences will
lead to differences in policy recommendations.
in markets, but they have little confidence in the ability of governments to improve
macroeconomic performance. Indeed, some believe that intervention is
counterproductive, for two reasons.
First, they recognize that there are important lags that make policymaking difficult.
It takes time for the government to recognize a problem—and the lags in getting
data, revisions in preliminary data, and the often conflicting information available
can leave policymakers in great uncertainty as they try to assess the state of the
economy. And after a problem is recognized, more time is needed before action can
be taken. The Federal Open Meeting Committee of the Federal Reserve meets frequently,
but fiscal policy actions may require congressional approval, which can
easily take many months to secure. Finally, there are time lags between when a policy
action is taken and when it has an impact on the economy. Interest rate changes by
the Fed, for example, take six months or more to significantly affect output and even
longer to influence inflation. Lags by themselves would not be a problem if the government
could accurately forecast. But everyone, including government economists,
sees the future with a cloudy crystal ball.
Because of these lags, the action may no longer be appropriate by the time its
effects are fully realized. Expansionary policies may finally take effect just as the
economy is already recovering, thereby encouraging inflation. Or contractionary
policies designed to slow inflation might affect the economy just as it is starting to
enter a recession, worsening the subsequent rise in unemployment.
Second, critics of strong interventionist policies argue that there are systematic
political reasons why interventionists are often misguided. Politicians want the
economy to expand before an election. They might boost government spending to overheat
the economy, winning gains in employment before the election but incurring
costs, in terms of higher inflation, that show up only after the election. In recent
THE GOALS OF MACROECONOMIC POLICY ∂ 845