Chapter 18. Stabilization Policy

Plus pages 435-36 on the Taylor Rule

Homework page 538 1, 3a-c

Link to syllabus

Recall Fig. 14-2, p. 405. Shifts in AD and Short Run Fluctuations

The big issue is howquickly the AS shiftsleft from AS1 to AS2.

Rational Expectations theorists say it happensvery quickly, thuscountercyclical policywon’t change outputnor employment much as the economy movesfrom A to C.

Fig. 10-12, 10-13, pp. 292, 295. Changes in AD

Rational expectations school argues that if government policy causesa change in AD, and that is known, there will be an immediateshift in SRAS, and so Y (output; therefore employment/unemployment)will not change, as the economy goes straight from A to C. In other words, countercyclical policy is not needed.

Fig. 18-1, p. 525. Forecasting the Recession of 1982

Milton Friedman, 1912-2006

Monetarism Monetary Growth ruleConsumption function (Introduced expectations into macro)Flexible exchange rates

Leader of anti-government movement, which we see in rejection of discretionary policies, and preference for rules.

Monetary Growth Rule ii

Monetary Growth Rule i

Bernanke’s testimony 11/16/05

When confronted with passages from a textbook he had written, in which he asserted that budget deficits tend to push up interest rates and "crowd out" private investments, he conceded that "it's possible" that tax cuts could cause more problems than they solve.

And in describing his approach, he sharply distanced it from those of some central banks that focus almost exclusively on an inflation target and not at all on promoting growth. "I don't agree with that," Mr. Bernanke declared flatly

In his first extended public appearance since President Bush nominated him to lead the Fed, Mr. Bernanke stoutly defended his proposal to base monetary policy on an explicit target for inflation and asserted that he would not weaken the central bank's "dual mandate" of promoting full employment as well as stable prices.

Figure 15-1, p. 436. Federal Funds Rate: Actual and Suggested

Taylor Rule, p. 435: Fed. Funds rate = π + 0.5(π - 2.0) + 0.5 (Y - Ybar)

Robert Lucas

Born 1937 in state of Washington

Parents were leftist, blue collar,working class.

Undergraduate major in history at U. of Chicago, where he has spentmost of his academic career.

Nobel Prize in 1995, primarily forwork in Rational Expectations.

Thomas Sargent

Born 1943 in Pasadena, California.B.A. at UC-Berkeley, Ph.D. Harvard, 1968

Nobel Prize, 2011 for his work in Rational Expectations (and related areas)

Taught at Penn, Minnesota, Stanford, and is now at NYU.

Describes himself as a Democrat, “a fiscally conservative, socially liberal Democrat,” adding, “I think that budget constraints are really central.” It’s important to consider the “incentive effects” of government policies, he continued. “There are trade-offs in efficiency and equality, and they lead to choices that aren’t easy,” he said. [NY Times]

Robert Barro, 1944-

Undergrad at CalTech in physics, Ph.D. fromHarvard. Taught for several years at Chicago,and now is at Harvard. Ex-columnist for Business Week.

Known as proponent of “Ricardian Equivalence,”positing that government deficit spending willnot increase aggregate demand, as people

will reduce current spending to save up for eventual repayment of thegovernment debt. (discussed in Chapter 19, pp. 554 ff). Not surprisingly, he is harshly critical of Keynesian countercyclical policies.

Has recently switched to the study of the economics of religion and culture on the macroeconomy.

Fig. 18-2, p. 535. Inflation and Central Bank Independence

Table 14-1 p. 388

Table 14-2, p. 391