Stabilisation Policy

Question 1

What are the arguments against active policy making ?

Answer 1

• policy lags are often long there are two types: inside lag which is the time between the shock and the reaction of policy makers. The other is the outside lag which is the time between the implementation of policy and its effect.
• Economic forecasting: Decisions must be based on forecast which have proven unreliable. Even current and past forecasts are prone to revision. Important events are hard to predict e.g Lehman brothers collapse.
• Lucas critique: Most macroeconomic models do not factor in expectations

Question 2

How is the time lag shortened ?

Answer 2

Automatic stabilisers they stimulate or contract the economy without the need of a change in policy because they are already in place. E.g when there is a recession tax income by the government is automatically lowered because people are making less money (tiered tax system)

Question 3

Give an example of an macroeconomic model that can be subjected to the Lucas critique.

Answer 3

-The macroeconomic model for disinflation (Phillips curve in output form). It is based on adaptive expectations (past values of inflation). Rational expectations means that if the government produces a credible plan to reduce inflation there may be no sacrifice ratio as people adjust their expectations accordingly.

Question 4

What is discretionary policy?

Answer 4

“When needed” attitude

Policy is set period by period as policy makers see fit. Implies active decision making

Question 5

What is rule policy making ?

Answer 5

It is when policy makers announce in advance how they will respond to certain shocks and make a credible commitment to this.

Question 6

What are the flaws of discretionary policy making ?

Answer 6

Ignorance incompetence: Governments and economists do not know how to stabilise the economy successfully. So a policy may be superficially attractive but may create more problems.
Pressure groups: Governments may be swayed by groups with a particular vested interest.
Opportunism: Governments may choose favourable policies near the time of an election to garner votes

Question 7

What is the time inconsistency of discretionary policy ?

Answer 7

Some policy makers may have an incentive to disengage on a policy when certain agents have formed their expectations. An example of this is when states say they do not negotiate with terrorists but disengage in this when there is a hostage situation.

Question 8

What type of rules are they and what do we use in the UK ?

Answer 8

Monetarist rule: set the target for money supply but this fell out of favour in the 80s because money demand is unstable.
Inflation targeting: currently used in the UK

Question 9

What type of approaches can government have towards policy making ?

Answer 9

Active or passive.

Rules vs discretion, rules can be active or passive but discretion will most likely be active ?