© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 18: Economic Performance and Political Economy

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 27 Chapter 18 Outline Introduction The Political Setting The Horizons and the Sequence of Effects Deficits Unlimited Why Not Government at All Levels? The Political Economy of Monetary Policy

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 27 Chapter 18 Outline Discretion and Rules Who is at the Controls? Renewal of the Debate What Lies Ahead?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 27 Introduction Policy makers talk about public interest –Actually respond to pressures of narrower interests Results of such policies –Less stability rather than more –Stagnation rather than economic growth

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 27 The Political Setting Public Policy –Reflects the interests of those who can extract benefits of the political process at a low cost. Preferred Policies –Short-term benefits and long-term costs. Public Policy –Reflects the ability of interested parties to articulate their request and monitor the politicians’ response.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 27 Time Horizons and the Sequence of Effects Changes in Aggregate Demand –Affects output and employment before affecting prices. Politically –Expansionary policy is preferred over contractionary policy because…

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 27 Time Horizons and the Sequence of Effects Politically –Favor policies yielding benefits on Well organized and well informed interest groups In the short run At the expense of costs borne by unorganized and ill-informed mass of voters.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 27 Deficits Unlimited Why do budget deficits persist when there is a majority support for a balanced budget?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 27 Deficits Unlimited $ $ $ $ $ $ $ $ $ $ $ $ $ $375.3

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 27 Deficits Unlimited WHAT DO YOU THINK? Are Congress and the President responsible for eliminating the deficit?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 27 Why Not Government at All Levels? State and local governments do not produce chronic deficits. The federal government did not produce chronic deficits prior to the 1970’s. State and local governments do not have control over the medium of exchange. Strong majority convictions influence public policy.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 27 Why Not Government at All Levels? Federal Government Debt as Percentage of GDP %

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 27 Why Not Government at All Levels? How did Keynesian economics impact our willingness to accept federal budget deficits?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 27 The Political Economy of Monetary Policy Question –Can the Fed prevent chronic deficits?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 27 The Political Economy of Monetary Policy Can the Fed prevent chronic deficits? –Fed is organized as an independent agency. –Congress could rewrite the Federal Reserve Act. –Radical action by Congress could create uncertainty over inflation.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 27 Discretion and Rules An Alternative to Discretionary Fiscal and Monetary Policy 1.Government expenditures without reference to a stabilization goal.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 27 Discretion and Rules An Alternative to Discretionary Fiscal and Monetary Policy 2.Tax rates set to balance the budget over a normal period.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 27 Discretion and Rules An Alternative to Discretionary Fiscal and Monetary Policy 3.The Fed should maintain a constant money stock for allowing moderate growth.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 27 Who Is at the Controls? Would a balanced budget amendment eliminate deficit spending and help stabilize the economy?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 27 Renewal of the Debate Question –Do markets allocate resources efficiently? Late 1980s and early 1990s –Capitalism reigned as the solution to the allocation questions.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 27 Renewal of the Debate Late 1990s –Economic difficulties in Russia, Brazil and the Pacific rim drew new attention to the economic role of government.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 27 Renewal of the Debate Question –What has caused the economic problems in: Russia? Japan? Malaysia and Indonesia? Brazil?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 27 Renewal of the Debate Question –Is it failed policy or simply market adjustments?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 27 What Lies Ahead? What do you think…?

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 27 Once Over Lightly Policymakers controlled by political processes. Stabilization policies affected by short time horizons. Unanticipated change in rate of growth of demand will affect output and employment before costs and prices.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 27 Once Over Lightly Political process tends to produce chronic budget deficits. Government contribution to economic stability might be to do “less”. Discretion stabilization policy vs. fixed rules. Economic failures in late 1990’s renewed debate over roles of governments and markets.

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 27 End of Chapter 18