PowerPoint Presentations for Principles of Macroeconomics Sixth Canadian Edition by Mankiw/Kneebone/McKenzie Adapted for the Sixth Canadian Edition by Marc Prud’homme University of Ottawa

FIVE DEBATES OVER MACROECONOMIC POLICY Chapter 17 Copyright © 2014 by Nelson Education Ltd.217-2

SHOULD MONETARY AND FISCAL POLICY MAKERS TRY TO STABILIZE THE ECONOMY?  Even if policy makers can influence short­run economic fluctuations, does that mean they should? 3Copyright © 2014 by Nelson Education Ltd.17-3

Pro: Policy Makers Should Try to Stabilize the Economy  While few would suggest that policy makers should respond to every minor rise and fall in the economy, there is no reason for society to suffer through the large booms and busts of the business cycle. 4Copyright © 2014 by Nelson Education Ltd.17-4

Con: Policy Makers Should Not Try to Stabilize the Economy  Although monetary and fiscal policy can be used to stabilize the economy in theory, there are substantial obstacles to the use of such policies in practice.  One problem is that monetary and fiscal policy do not affect the economy immediately but instead work with a long lag. 5Copyright © 2014 by Nelson Education Ltd.17-5

QuickQuiz Explain why monetary and fiscal policy work with a lag. Why do these lags matter in the choice between active and passive policy? Copyright © 2014 by Nelson Education Ltd.17-6

SHOULD MONETARY POLICY BE MADE BY AN INDEPENDENT CENTRAL BANK?  Some economists are critical of the Bank of Canada’s independence.  The second debate over macroeconomic policy focuses on whether the bank should be allowed to conduct monetary policy without being directly answerable to the electorate or to elected officials. 7Copyright © 2014 by Nelson Education Ltd.17-7

Pro: Monetary Policy Should Be Made By an Independent Central Bank  Allowing elected officials to have influence in conducting monetary policy has two problems:  When given this power, politicians are sometimes tempted to use monetary policy to affect the outcome of elections.  Allowing elected officials a say in conducting monetary policy might lead to more inflation than is desirable. 8Copyright © 2014 by Nelson Education Ltd.17-8

 Although there are pitfalls in allowing elected policy makers a say in conducting monetary policy, there is also an important advantage: accountability. 9Copyright © 2014 by Nelson Education Ltd.17-9 Con: Monetary Policy Should Not Be Made By an Independent Central Bank

QuickQuiz Should the governor of the Bank of Canada be elected? Explain. Copyright © 2014 by Nelson Education Ltd.17-10

SHOULD THE CENTRAL BANK AIM FOR ZERO INFLATION?  How much inflation should the central bank be willing to tolerate?  Our third debate is whether zero is the right target for the inflation rate. 11Copyright © 2014 by Nelson Education Ltd.17-11

Pro: The Central Bank Should Aim for Zero Inflation  Inflation confers no benefit on society, but it imposes several real costs.  Economists have identified six costs of inflation.  Some economists claim these costs can be substantial, even for moderate inflation. 12Copyright © 2014 by Nelson Education Ltd.17-12

Con: The Central Bank Should Not Aim for Zero Inflation  Although price stability may be desirable, the benefits of zero inflation compared with moderate inflation are small, whereas the costs of reaching zero inflation are large. 13Copyright © 2014 by Nelson Education Ltd.17-13

14Copyright © 2014 by Nelson Education Ltd. Suppose a structural change has reduced the demand for university administrators, lowering their equilibrium real wage by 3 percent. A.If the actual real wage paid to university administrators remains constant, what would be the consequences? B.Would it be easier to achieve the 3 percent real wage reduction if the inflation rate is 0 percent or if it is 4 percent? Why? Active Learning Another Issue in the Zero Inflation Debate

15Copyright © 2014 by Nelson Education Ltd. A.If the actual real wage paid to university administrators remains constant, what would be the consequences? Whenever the actual real wage exceeds the equilibrium real wage, there is a surplus of labour, which represents wasted resources. A fall in the wage would encourage some administrators to switch to university teaching or private sector employment Active Learning Answers

16Copyright © 2014 by Nelson Education Ltd. B.Would it be easier to achieve the 3 percent real wage reduction if the inflation rate is 0 percent or if it is 4 percent? Why? To restore labour market equilibrium under 0 percent inflation, administrators would have to accept a 3 percent nominal wage cut. Under 4 percent inflation, they would have to accept a 1 percent nominal wage increase. The second scenario is more likely, as many people suffer from “money illusion” and focus on nominal variables rather than real ones Active Learning Answers

QuickQuiz Explain the costs and benefits of reducing inflation to zero. Which are temporary and which are permanent? Copyright © 2014 by Nelson Education Ltd.17-17

SHOULD GOVERNMENTS BALANCE THEIR BUDGETS?  Should fiscal policy makers make balancing the government’s budget a high priority? 18Copyright © 2014 by Nelson Education Ltd.17-18

Pro: Governments Should Balance Their Budgets  The most direct effect of the government debt is to place a burden on future generations of taxpayers.  They lower national saving.  They increase the default risk. 19Copyright © 2014 by Nelson Education Ltd.17-19

Con: Governments Should Not Balance Their Budgets  The government debt does represent a tax burden on younger generations, but it is not large compared to the average person’s lifetime income.  It is misleading to view the effects of budget deficits in isolation. 20Copyright © 2014 by Nelson Education Ltd.17-20

QuickQuiz Explain how reducing government debt makes future generations better off. What fiscal policy might improve the lives of future generations more than reducing the government debt? Copyright © 2014 by Nelson Education Ltd.17-21

SHOULD TAX LAWS BE REFORMED TO ENCOURAGE SAVING?  Should policy makers reform the tax laws to encourage greater saving and investment? 22Copyright © 2014 by Nelson Education Ltd.17-22

Pro: Tax Laws Should Be Reformed to Encourage Saving  International data show a strong correlation between national saving rates and measures of economic well­being. 23Copyright © 2014 by Nelson Education Ltd.17-23

Con: Tax Laws Should Not Be Reformed to Encourage Saving  The problem with proposals to increase the incentive to save is that they increase the tax burden on those who can least afford it. 24Copyright © 2014 by Nelson Education Ltd.17-24

QuickQuiz Give three examples of how our society discourages saving. What are the drawbacks of eliminating these disincentives? Copyright © 2014 by Nelson Education Ltd.17-25

THE END Chapter 17 Copyright © 2014 by Nelson Education Ltd