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

Review and Practice
SUMMARY
1. The traditional view of government deficits argues that
deficits reduce national saving, raise the equilibrium real
interest rate, and crowd out private investment spending.
The result is less capital and lower incomes in the
future. The burden of government deficits falls on future
generations.
2. Under Ricardian equivalence, individuals understand
that deficits today mean higher taxes in the future.
Those in the private sector increase their saving in
anticipation of the higher future taxes. Thus, national
saving does not fall and deficits do not matter.
3. Those who criticize active policy intervention to stabilize
the economy argue that markets adjust quickly,
making unemployment only short-lived. Attempts by
government to intervene are not only unnecessary but
largely ineffective, since they are offset by actions of
the private sector. And to the extent that they do have
effects, such policies often exacerbate fluctuations,
because there are long lags, because the government has
limited information, and because political pressures lead
it to overheat the economy before elections.
4. Critics of discretionary policy believe that the government
should tie its hands by using fixed rules. Discretionary
policies may be inconsistent over time, leading
to worse outcomes than occur when government follows
predictable rules. Critics of fixed rules argue that by
embracing them government gives up an important set
of instruments and that fixed rules never work well
because they fail to respond to the ever-changing
structure of the economy.
5. The proponents of inflation targeting in the United
States argue that it will make the Fed more accountable,
increase the credibility of the Fed’s low inflation policy,
and institutionalize good policies.
6. Opponents of inflation targeting argue that it elevates
one goal of monetary policy at the expense of other
goals, limits Fed flexibility, and is unnecessary.
7. Aggregate supply shocks require policymakers to balance
the goals of full employment and stable inflation.
To achieve one goal, the other must be sacrificed.
Aggregate demand shocks create no inherent conflict
between these goals.
8. Disturbances such as oil price changes or shifts in
inflationary expectations force policymakers to face a
trade-off between stabilizing unemployment and stabilizing
inflation. If the central bank adjusts interest rates
more aggressively to changes in inflation, it can make
inflation more stable, but output and employment will
fluctuate more.
KEY TERMS
rules
discretion
dynamic inconsistency
countercyclical policies
inflation targeting
price level targeting
REVIEW QUESTIONS
1. Why might a government budget deficit reduce the
economy’s future stock of capital?
2. Suppose the government cuts taxes. If households
save all of their tax cut, will the real interest rate and
investment be affected? Explain.
3. What is meant by Ricardian equivalence?
4. How do inflation and unemployment affect different
groups differently, and how do these differences affect
views on macroeconomic policy?
5. Why do some economists argue that interventions to
reduce economic fluctuations are either ineffective or
counterproductive?
6. What is meant by dynamic inconsistency? Give at
least two examples of policies that are dynamically
inconsistent.
7. Why do some economists argue that interventions
to reduce economic fluctuations are effective and
productive?
8. What are the pros and cons of inflation targeting?
9. What trade-off between average unemployment and
average inflation do policymakers face? What trade-off
860 ∂ CHAPTER 38 CONTROVERSIES IN MACROECONOMIC POLICY