Macroeconomics Week 7: Alternative Perspectives on Stabilisation Policy

Question 1

Describe the 2 views for this question: ‘How should fiscal and monetary policymakers respond
to the business cycle (short-run economic fluctuations)?’

Answer 1

Broadly speaking, there are two views:
* The economy is inherently unstable and requires
government intervention from time-to-time to ‘offset’ fluctuations (e.g. shocks). Mostly Keynesian economists believe this - Keynes’ beliefs came about following the Great Depression. Aka ‘active’ approach
* The economy is inherently stable and government
intervention only interferes with the ‘natural’ balancing process, potentially even exacerbating existing fluctuations. Neoclassical economists tend to believe this. Aka ‘passive’ approach

Question 2

Are ‘rules’ for government policy active or passive?

Answer 2

They can be either

Question 3

Is ‘discretion’ for government policy active or passive?

Answer 3

Almost certainly active

Question 4

Describe & explain the arguments against active policy to stabilise economies

Answer 4

Policy lags:
* The economy is more like a ship than a car;
interventionist policymakers tend to ‘oversteer’.
* Lags are “long and variable” (Friedman).
* Inside lag: the delay between a shock hitting the
economy and policymakers’ reaction (e.g. information
lags or legislative delays). Information lag can happen because institutions don’t measure data in real time, and even once data is recorded, data can get revised. Fiscal policy tends to have legislative delay. For example, if the government has a small majority in parliament, decisions would have to go to a vote, they might lose and more legislative delay could cause inside lag
* Outside lag: the delay between a policy action and its
impact on the economy.
The state of the economy might change in the meantime;
it then takes time to correct the ‘mistaken’ policy.
- For Bank of England interest rate rises implemented in Q4 2021, only 60% pass through to the economy by Q1 2024 and it isn’t expected to 100% pass through to the economy until Q1 2025 (FT, 2024)