1. Principles of Macroeconomics 3250:201
Richard W. Stratton

2. The University of Akron
Administration
4 graded assignments next week
Homework 13, 14
Essay 04
CBT Test 05 (Thursday - Saturday)
9/21/2018
The University of Akron
Decision Tree

3. Policy Debates: Introduction
Questions needing consideration
To intervene or Not?
Are policy rules sufficient or is Discretionary policy necessary?
Is the an advantage to either Fiscal or Monetary Policy?
What is the Shape of the AS curve? Why does it matter?
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4. Policy Debates: Introduction
Questions continued
Is there an “best” Policy target?
Price level or GDP
Interest rate or money supply
Inflation rate = zero
Is social welfare dependent more on inflation or unemployment?
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5. Policy Debates: Introduction
Questions continued
Is Balancing the budget important?
To what extent do Tax laws impact saving?
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6. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

7. The University of Akron
Review Readings – Chp. 18
Recall - List 3 main ideas in chapter 18
Summarize – In your own words describe the purpose of chapter 18
Question - Write 1 unanswered question you have from chapter 18
Comment – What is your general impression of this chapter?
Connect something in this chapter to your life
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8. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

9. Discretionary or Policy rules
depends on the judgment of policy makers and their interpretation of current and forecast events
Fixed-rule
allows the money supply to grow at a pre-specified rate
Feedback rules
pre-specify how the policy action responds to changing events
Example: M2 to grow at 3% per year
Example: Adjust M2 to maintain a constant interest rate of 3% on 6 month government securities
9/21/2018
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10. Discretionary or Policy rules
State of economic knowledge
Knowledge of potential GDP
Policy lags and forecast horizon
Predictability of policies
Can we effectively use economic data to determine our current conditions?
Can we determine the “Natural rate of UE and thus the potential GDP?
Policies take 12 – 18 months to impact the economy. How accurate are forecasts?
How predictable are the results of policy actions? Might they contribute to instability?
9/21/2018
The University of Akron

11. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

12. Fiscal or Monetary Policy
What are the necessary steps to use discretionary policy?
Timely recognition of situation
Policy formation
Policy implementation
Policy impacts the economy
9/21/2018
The University of Akron

13. Fiscal or Monetary Policy
What are the necessary steps to use discretionary policy?
Timely recognition of situation
Measure current economic conditions
Economic forecast
Compare with desired conditions
9/21/2018
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14. Fiscal or Monetary Policy
What are the necessary steps to use discretionary policy?
Policy formation
Formulate direction
Choose policy tool
Determine magnitude needed
9/21/2018
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15. Fiscal or Monetary Policy
What are the necessary steps to use discretionary policy?
Policy implementation
Policy impacts the economy
Short-run
Long-run
9/21/2018
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16. Fiscal or Monetary Policy
Does either Fiscal or Monetary policy have a clear advantage?
Timely recognition of situation
Policy formation
Policy implementation
Policy impacts the economy
9/21/2018
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17. Fiscal or Monetary Policy
What influences either Fiscal or Monetary policy’s impact?
Fiscal Policy
Monetary Policy
Elasticity of Md
Elasticity of Id
Size of government spending multiplier
Size of investment multiplier
Crowding-out effect
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18. Fiscal or Monetary Policy
Fiscal or Monetary policy goals
Fiscal Policy
Monetary Policy
Provide public goods
Price stability
Redistribute income
Real GDP stability
Stabilize AD
Stability of financial system
9/21/2018
The University of Akron

19. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

20. The University of Akron
Shape of the AS curve
Shape of the AS curve
If AS is very elastic
A given change in AD leads to small change in inflation
If AS is very inelastic
A given change in AD leads to large change in inflation
9/21/2018
The University of Akron

21. The University of Akron
Shape of the AS curve
Shape of the AS curve
If AS is very elastic
SRAS
Increased AD => little inflation
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The University of Akron

22. The University of Akron
Shape of the AS curve
Shape of the AS curve
If AS is very inelastic
SRAS
Increased AD => large inflation
9/21/2018
The University of Akron

23. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

24. The University of Akron
Policy target
Selecting the appropriate target
Price level
Is a zero rate of inflation desirable?
Real GDP
Interest rate
Money supply – monetary base
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The University of Akron

25. The University of Akron
Policy target
Selecting Price level as target
AD and AS shocks are met with policies to minimize price changes
Increase in AS => must increase AD
Decrease in AS => must decrease AD
Increase in AD => must decrease AD
Decrease in AD => must increase AD
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The University of Akron

26. Policy target – AS shock
Selecting Price level as target
Price AS AD
Real GDP
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27. Policy target –AD shock
Selecting Price level as target
Price AS AD
Real GDP
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28. The University of Akron
Policy target
Selecting the Real GDP target
AD and AS shocks are met with policies to minimize GDP changes
Increase in AS => must decrease AD
Decrease in AS => must increase AD
Increase in AD => must decrease AD
Decrease in AD => must increase AD
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The University of Akron

29. Policy target – AS shock
Selecting real GDP as target
Price AS AD
Real GDP
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30. Policy target –AD shock
Selecting real GDP as target
Price AS AD
Real GDP
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31. The University of Akron
Policy target
Selecting the Interest rate target
AD and AS shocks are met with policies to minimize interest rate changes
Thus Ms must move in the same direction as Md
9/21/2018
The University of Akron

32. The University of Akron
Policy target
Selecting the Interest rate target
Increase in AS => increase in real GDP, but a decrease in price level
Decrease in AS => decrease in real GDP, but an increase in price level
So direction of monetary policy is uncertain
9/21/2018
The University of Akron

33. The University of Akron
Policy target
Selecting the Interest rate target
Increase in AD => increase in both real GDP and in price level
Md => Ms
Decrease in AD => decrease in both real GDP and in price level
Md => Ms
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The University of Akron

34. Policy target – AS shock
Selecting Interest rate as target
Interest rate Ms Md
Quantity of Money
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The University of Akron

35. The University of Akron
Policy target
Selecting the Money supply target
AD and AS shocks are met with policies to minimize Ms changes
No matter what AD and AS do, keep Ms constant
Or growing a constant rate
9/21/2018
The University of Akron

36. Policy target – AS shock
Selecting Money Supply as target
Interest rate Ms Md
Quantity of Money
9/21/2018
The University of Akron

37. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

38. The University of Akron
Balance budget
Is balancing the government budget annually desirable?
During recession
During an expansion
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The University of Akron

39. The University of Akron
Balance budget
Is balancing the government budget annually desirable? If not?
Can it be balanced over business cycle?
Unified budget?
9/21/2018
The University of Akron

40. The University of Akron
Balance budget
Is balancing the government budget annually desirable? If not?
Can it be balanced over business cycle?
Are we talking about the operating budget? Or the Unified budget?
Does it matter?
9/21/2018
The University of Akron

41. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

42. The University of Akron
Tax laws and saving
Tax laws and saving
Do we need to increase the rate of private saving?
If so, can tax policy increase the saving rate?
If so, is it the most efficient way to increase the saving rate?
9/21/2018
The University of Akron

43. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14

44. The University of Akron
Worksheet 14 - Scenario 1
Scenario 1
Md relatively interest rate elastic
Id relatively interest rate inelastic
Fed Purchase $75 billion bonds
9/21/2018
The University of Akron

45. The University of Akron
Worksheet 14 - Scenario 1
Md relatively interest rate elastic
Ms0 i Md
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46. The University of Akron
Worksheet 14 - Scenario 1
Id relatively interest rate inelastic Id i
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47. The University of Akron
Worksheet 14 - Scenario 1
Current situation
Ms0 Id i i Md
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The University of Akron

48. The University of Akron
Worksheet 14 - Scenario 1
Fed Purchase $75 billion bonds
Ms0
Ms1 Id i i Md
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The University of Akron

49. The University of Akron
Worksheet 14 - Scenario 1
Scenario 1
Md relatively interest rate elastic
Id relatively interest rate inelastic
Fed Purchase $75 billion bonds
Relatively little impact on interest rates
Relatively little impact on planned investment
9/21/2018
The University of Akron

50. The University of Akron
Worksheet 14 - Scenario 1
Scenario 1
Md relatively interest rate elastic
Id relatively interest rate inelastic
Increase federal deficit by $125 billion
Decrease taxes
Increase spending
Some of both
9/21/2018
The University of Akron

51. The University of Akron
Worksheet 14 - Scenario 1
Increase federal deficit by $125 bil.
Increase demand
reduces private
investment only
slightly.
Id0
Id1 i SS
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The University of Akron

52. The University of Akron
Worksheet 14 - Scenario 1
Increase federal deficit by $125 bil.
Ms0
Ms1 Id i i Md
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The University of Akron

53. The University of Akron
Worksheet 14 - Scenario 2
Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity.
This is an example of discretionary monetary policy.
This is a poor economic policy; it will tend to make business cycle fluctuations greater.
9/21/2018
The University of Akron

54. The University of Akron
Worksheet 14 - Scenario 2
Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity.
This is an example of discretionary monetary policy.
False; It is either a feedback rule or a misstatement of a fixed rule.
9/21/2018
The University of Akron

55. The University of Akron
Worksheet 14 - Scenario 2
Federal Reserve Board will increase the M2 supply of money annually by a percentage equal to the rate of growth of real GDP minus the rate of growth in labor productivity.
This is a poor economic policy; it will tend to make business cycle fluctuations greater.
True: This would have expansionary policy during expansions and contractionary policy during contractions.
9/21/2018
The University of Akron

56. Student Questions Discretion or Rules Fiscal or Monetary AS curve
Decision Tree
Student Questions
Discretion or Rules
Fiscal or Monetary
AS curve
Policy target
Balance budget
Taxes & saving
Worksheet 14