CHAPTER 8
Soluti ons to the Problems in the Textbook: Con ceptual Problems:
1. The first question you should ask yourself as a policy maker is whether a disturbanee is transitory or
persiste nt. You should the n ask yourself how long it would take to put a suggested policy measure into effect and how long it will take for the policy to have the desired effect on the economy. In addition, you need to know how reliable the estimates of your advisors are about the effects of the policy. If a disturbanee is small and probably transitory, you may be best advised to do nothing, because any measure you take is likely to have its effect after the economy has recovered. Therefore your acti on might only further aggravate the problem.
2. a. The in side lag is the time it takes after an econo mic disturba nce has occurred to recog nize and
impleme nt a policy action that will address the disturba nce.
2. b. The in side lag is divided into three parts. First, there is the recog niti on lag, that is, the time it takes
for policy makers to realize that a disturbance has occurred and that a policy response is warranted. Second, there is the decision lag, that is, the time it takes to decide on the most desirable policy resp onse after a disturba nce is recog ni zed. Fin ally, there is the acti on lag, that is, the time it takes to actually impleme nt the policy measure.
2. c. Inside lags are shorter for monetary policy than for fiscal policy since the FOMC meets on a regular
basis to discuss and impleme nt mon etary policy. Fiscal policy, on the other hand, has to be in itiated and passed by both houses of the U.S. Con gress and this can be a len gthy process. The excepti ons are the so-called automatic stabilizers; however, they only work well for small and transitory disturbances
2. d Automatic stabilizers have no in side lag; they are en doge nous and function without specific
gover nment in terve nti on. Examples are the in come tax system, the welfare system, un employme nt in sura nce, and the Social Security system. They all reduce the amount by which output cha nges in resp onse to an econo mic disturba nce.
3. a. The outside lag is the time it takes for a policy action, once implemented, to have its full effect on the
economy.
3. b. Gen erally, the outside lag is a distributed lag with a small immediate effect and a larger overall effect
over a Ion ger time period. The effect is spread over time, since aggregate dema nd resp onds to any
policy change only slowly and with a lag.
3. c. Outside lags are longer for monetary policy since monetary policy actions affect short-term interest
rates most directly, while aggregate demand depends heavily on lagged values of income, interest rates, and other economic variables. A change in government spending, however, immediately affects aggregate demand.
4. Fiscal policy has smaller outside lags, but significant inside lags. Monetary policy, on the other hand has
smaller inside lags and longer outside lags. Therefore large open market operations should be undertaken to get an immediate effect, but they should be partially reversed over time to avoid a large long-run effect. If the shock is sufficiently transitory and small, policy makers may be best advised not to undertake any policy change at all.
5. a. An econometric model is a statistical description of all or part of the economy. It consists of a set of
equations that are based on past economic behavior.
5.b. Econometric models are generally used to forecast the behavior of the economy and the effects of
alternative policy measures.
5.c. There is considerable uncertainty about how well econometric models actually represent the workings of
the economy. There is also great uncertainty about the expectations of firms and consumers and their reactions to policy changes. Any policy is bound to fail if the information on which it was based is poor.
6. The answer to this question is student specific. The main difficulties of stabilization policy arise from
three sources. First, policy always works with lags. Second, the outcome of any policy depends on the way the private sector forms expectations and how those expectations affect the public's behavior. Third, there is considerable uncertainty about the structure of the economy and the shocks that hit it. It can be argued that a monetary policy rule would greatly reduce uncertainty about the Fed's policy responses. If the government behaved in a consistent way, then the private sector would also behave more consistently and economic fluctuations could be greatly reduced. A monetary growth rule would also reduce any political pressure the administration might exert on the Fed. It is often initially unclear whether a disturbance is temporary or persistent and a monetary policy rule would prevent policy mistakes in cases where the disturbance is, in fact, temporary. If active monetary policy is applied to a temporary disturbance, then the lags involved will guarantee that the economy will actually be destabilized.
On the other hand, the workings of the economy are not completely understood and events cannot
always be predicted. Thus it is difficult to argue for a fixed policy rule. Unanticipated large disturbances warrant an activist policy, especially if they appear to be persistent. It is also possible to construct a more activist monetary growth rule. For example, Equation (8) suggests that the annual monetary growth rate should be increased by two percent for every one percent that unemployment increases above its natural rate. Such a rule is based on the quantity theory of money equation (which relates money supply growth to the growth of nominal GDP) and on Okun's law (which relates the unemployment rate to economic growth). Obviously, because of the long lags for monetary policy, any monetary growth rule will work much better in the long run than in the short run.
Fiscal policy rules may make more sense than monetary policy rules, since fiscal policy has long inside lags but shorter outside lags. In a way, built-in stabilizers, although generally not considered \already provide some stability without any inside lag. Many of the arguments against monetary policy rules are also valid for fiscal policy rules and many economists oppose them. The frequently proposed constitutional amendment requiring an annually balanced budget is an example of a fiscal policy rule. There are significant problems associated with such an amendment, since it would greatly limit the government's ability to undertake active fiscal stabilization policy.
7. The arguments for a constant growth rate rule for money are based on the quantity theory of money
equation, that is, MV = PY.
From this equation we can derive % P = % M - % Y + % V.
If the long-run trend rate of real output (Y) and the long-run trend of velocity (V) are assumed to be fairly stable, and if wages and prices are sufficiently flexible, then a constant monetary growth rate (M) would insure a constant rate of inflation, that is, a constant rate of change in the price level (P). Also, since monetary policy has long outside lags, active monetary policy can actually be more destabilizing than stabilizing. In addition, since we do not know exactly how the economy works or may react to specific policies, it is best to follow a rule rather than undertake actions that have uncertain outcomes. However, rules are not without problems, as they would not allow flexibility in responding to major disturbances.
8. Dynamic inconsistency occurs if, after having committed themselves to a specific policy action designed
to achieve a long-run objective, policy makers find themselves in a situation where it seems advantageous to abandon their original policy, in order to achieve a short-run goal. Such action will
多恩布什宏观经济学第十版课后习题答案08
