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Week 9: Macroeconomic policy (Stabilisation policy (Stabilisation policy…
Week 9: Macroeconomic policy
Stabilisation policy
The role of stabilisation policy
Slow self- correction process
due to long- term contracts
due to the imperfections in the product and labour markets
warrants the introduction of stabilisation policy
Stabilisation policy should only be used if there is a
large output gap
Stabilisation policy and demand shocks
How to increase aggregate demand?
Fiscal policy
increase government spending
tax cuts
Monetary policy (lower the interest rate)
stimulate increased investment spending
increase planned spending and output
Stabilisation policy and inflation shocks
shocks to aggregate supply
targeting a low inflation rate? and securing output stability?
maintains the
initial target inflation rate
in the face of a supply shock => the economy may experience a protracted
contractionary or expansionary gap
Accommodating policy
allows the effect of a shock to occur
in the short run, higher inflation caused by the inflation shock, followed by an increase in output with inflation rising even higher (bank
lower the real interest rate
to
increase aggregate demand
)
in the long run, economy returns to potential output, but now has a higher inflation rate. (
Shorter and shallower recession?
)
Anchored inflationary expectations
people's expectations of future inflation do not change even if inflation rises temporarily
businesses and consumers believe the Reserve Bank will reestablish its target inflation rate => firms will less likely to raise price =>
shortens
the time to close the recessionary gap from the shock
How was US inflation conquered in the 1980s?
Great Moderation?
An alternative view explaining stability
Credibility of monetary policy
The degree to which the
public believes
the Reserve Bank will keep the inflation rate low
The more credible policy, the more inflation is
anchored
Factors that affect credibility
(read the ppt for more details)
Degree of Central Bank's
independence
: central bankers are
insulated from short- term political considerations
and are allowed to take a long- term view of the economy
The announcements of
explicit inflation targets
:some countries use announced targets or a narrow range for inflation.
Why shouldn't the inflation target be zero?
(read more in the ppt)
Established reputation for fighting inflation
An inflation hawk:
more successful
in maintaining stable output and employment
An inflation dove
Supply- side policy
policy that affects potential outputs
Marginal tax rate: tax on an additional dollar
Average tax = Total tax/ Pre- tax income
Policy making: art or science? (
read the ppt for more details
)
Macroeconomic policy works best with
Barriers to perfect policies
Inside lag: the delay between the date a policy change is needed and the date it is implemented
Outside lag: the delay between policy implementation and when the major effects of the policy occur.