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Economics U$A: 21st Century Edition

Stabilization Policy (Macroeconomics)

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Between 1982 and 1985, the Fed tightened the money supply to combat inflation, despite rising unemployment. Also in the 1980s, U.S. citizens began to feel the debilitating effects foreign trade would have on job loss. Paul Volker’s monetary policy in the mid-1980s was designed to quell inflation once and for all. However, in the first decade of the 21st century, when unemployment skyrocketed and the banking system and major corporations needed a bailout to survive, we questioned whether we could still control the economy. These stories highlight arguments for and against active government counter-stabilization policy.

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Unit Overview

Purpose:

To discuss the arguments for and against active government counterstabilization policy.

Objectives:

  1. Classical and neo-classical economists believe that there is little the government can do to reduce unemployment and increase GDP/GNP growth, especially in the long run. They maintain that in the long run, fiscal stimulus raises interest rates and monetary stimulus raises prices without affecting real growth.
  2. Expectations may reduce the effectiveness of government stabilization policies.
    • Expectations that the government will reverse an anti-inflation policy will keep the policy from being effective.
    • “Rational expectations’ may keep a stimulative policy from lowering unemployment because individuals and firms may simply demand higher wages and prices.
  3. It is difficult to determine exactly what monetary policy to pursue because neither interest rates nor the money supply are perfect indicators of the restrictiveness of monetary policy.
  4. Government fiscal policy has often been complicated by political problems, and large structural deficits make it even more difficult to use discretionary fiscal policies.
  5. Financial mania and panics are “hardy perennials.” They progress in rather predictable phases and occur altogether too frequently, if you include the experience of other countries as well. While there is disagreement about whether or not they can be prevented, there is a consensus that, with good policies, they can be moderated and that the economic damage from them can be managed.

Meet the Series Experts

Douglas Elliot

Fellow at the Brookings Institution, specializing in the regulation of financial institutions and markets. A financial institutions investment banker for two decades, principally at J.P. Morgan, he was the founder and principal researcher for the Center on Federal Financial Institutions. He has researched financial institutions or worked directly with them as clients in a range of capacities, including as an equities analyst, credit analyst, mergers and acquisitions specialist, relationship officer, and specialist in securitizations. His work encompasses banks, insurers, funds management firms, and other financial institutions. Mr. Elliott received an A.B. in Sociology from Harvard College and an M.A. in Computer Science from Duke University.

Beryl Sprinkel

Chairman of the U.S. Council of Economic Advisers under President Ronald Reagan and author or co-author of many articles and books that discuss effects of monetary policy on financial markets and the economy. He was Executive Vice President at the Harris Trust and Savings Bank of Chicago and a consultant to Congressional committees and government agencies, including four years as Under Secretary of the Treasury for Monetary Affairs. He also taught economics and finance at the University of Missouri School of Business and Public Administration and the University of Chicago Booth School of Business. He has been a member of Time magazine’s board of economists, Chairman of the Economic Advisory Committee of the American Bankers Association, a member of the Board of Directors of the U.S. Chamber of Commerce, and a founding member of the Shadow Open Market Committee. Dr. Sprinkel received his B.S. in Public Administration and B.S. in Economics at the University of Missouri and M.B.A. and Ph.D. in Economics from the University of Chicago.

Frederick H. Schultz

Private Investor, owner of Schultz Investments, Vice Chairman of the Board of Governors of the Federal Reserve System, 1979–1982, and member of the Florida House of Representatives, 1963–1970. He served in the U.S. Army, 1952–1954, and was employed by the Barnett Bank of Jacksonville, Florida, 1956–1957. He also served as Chairman of the Board of Barnett Investment Services, Inc., and as a Director of a number of private companies and banks, including Transco Energy Company, the American Heritage Life Insurance Co., Riverside Group, Inc., Family Steak Houses of Florida and Southeast Atlantic Corp, Wickes, Inc., and Barnett Banks, Inc. Mr. Schultz received his B.A. from Princeton University. He attended the University of Florida College of Law, graduating with his law degree in 1956.

Martin Feldstein

Professor of Economics at Harvard University, President Emeritus of the National Bureau of Economic Research, and President Ronald Reagan’s Chairman of the Council of Economic Advisers. President George W. Bush appointed him a member of the President’s Foreign Intelligence Advisory Board, and, in 2009, President Barack Obama appointed him a member of the President’s Economic Recovery Advisory Board. He is a member of the American Philosophical Society, a Fellow of the Econometric Society, and a Fellow of the National Association of Business Economics. He is also a Trustee of the Council on Foreign Relations and a member of the Trilateral Commission, the Group of Thirty, the American Academy of Arts and Sciences, and the Council of Academic Advisors of the American Enterprise Institute. He is the author of more than 300 research articles in economics and a regular contributor to the Wall Street Journal and other publications. Dr. Feldstein received his B.A. from Harvard University and B.Litt. and D.Phil. from the University of Oxford.

Karen Petrou

Co-founder and Managing Partner of Federal Financial Analytics, Inc., a privately held company that provides analytical and advisory services on legislative, regulatory, and public-policy issues affecting financial services companies doing business in the U.S. and abroad. She is a frequent speaker on topics affecting the financial services industry. In addition to presentations to Congress and government agencies, she has spoken before the American Bankers Association, the Financial Services Roundtable, the American Bar Association, the Brookings Institution, the American Institute of Certified Public Accountants, the National Association of Manufacturers, and many other groups. She has also authored many articles in publications such as American Banker, Bankers Magazine, and International Economy, as well as general-interest media like the New York Times and the Wall Street Journal. Ms. Petrou received her B.A. from Wellesley and M.A. in Political Science from the University of California at Berkeley, where she was also a doctoral candidate.

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Quiz Addendum

4. Answer Explanation:
Eliminate the lag between monetary policy enactment and impact. There is no guarantee that the first option would occur, though some monetarists believe the fixed-rate rule would ease unemployment problems. The third option might be partly true, though the Fed would still be a powerful agency, and this is not an argument that has been used in favor of the fixed-rate rule. The fourth option is plainly false since economic slowdown, and not runaway growth, has been the problem of the past few years.

Glossary

  • constant growth rate rule
    A policy that targets a constant growth rate for a specific economic variable. Monetarists argue for a constant money supply growth rate to facilitate a certain nominal GDP growth rate.
  • credibility of government policies
    A concept dealing with the likelihood that a policy authority will stick to an announced policy. The less flexibility a policymaker has in deviating from the announced policy, the more credible that policy becomes.
  • creeping inflation
    An increase in the general price level of a few percent per year that gradually erodes the value of money.
  • inside policy lag
    The amount of time it takes for a government or a central bank to respond to a shock in the economy.
  • outside policy lag
    The time between corrective government action responding to a shock to the economy and the resulting effect on the economy.
  • rational expectations
    Expectations that are correct on the average (forecasting errors are random). The forecaster makes the best possible use of whatever information is available.
  • structural deficit
    The difference between government expenditures and tax revenues that would result if gross domestic product were at its potential, not its actual, level.

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Economics U$A: 21st Century Edition

Credits

Produced by the Educational Film Center. 2012.
  • Closed Captioning
  • ISBN: 1-57680-895-5