Current Topics in Macroeconomics: Questions for Debate
Read each of the four webpages linked from this section: "Arguments For and Against Discretionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Monetary Policy," "Arguments For and Against Fighting Recession with Expansionary Fiscal Policy," and "Arguments For and Against Inflation Targeting Policy Interventions". You will gain additional insights about policy formation, implementation, and evaluation. In each case, consider whether the right questions were asked and whether the proper measures received focus. Which side of each of these debates would you find yourself?
Arguments For and Against Fighting Recession with Expansionary Monetary Policy
Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates.
LEARNING OBJECTIVE
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Understand the value of discretionary expansionary monetary policy and the associated shortcomings.
KEY POINTS
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The success of monetary policy intervention rests on the credibility of the central bank on one hand and the understanding of central bank operations related to interest rates and money supply effects on the part of the public, in general.
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Without central bank credibility with respect to low interest rate targets, economic agents may assume that expansionary policy will lead to inflation and begin augmenting behavior to initiate the outcome expected, higher inflation.
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Announcements can be made credible in various ways. One method would be to establish an independent central bank with low inflation targets (but no output targets).
TERMS
- discretionary
Available at one's discretion; able to be used as one chooses; left to or regulated by one's own discretion or judgment.
- expansionary monetary policy
Traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into investing, leading to overall economic growth. Monetary policy, to a great extent, is the management of expectations between interest rates, the price of the use of money, and the total supply of money. Monetary policy uses a variety of discretionary tools to control one or both of these to influence outcomes like economic growth, inflation, exchange rates with other currencies, and unemployment. When the central bank is in complete control of the money supply, the monetary authority has the ability to alter the money supply and influence the interest rate to achieve policy goals.
However, the success of monetary policy intervention rests on the credibility of the central bank on one hand and the understanding of central bank operations related to interest rates and money supply effects on the part of the public, in general. For example, if the central bank is implementing expansionary policy but is committed to keeping interest rates low, the central bank needs to convey this policy with credibility, otherwise economic agents may assume that expansionary policy will lead to inflation and begin augmenting behavior to initiate the outcome expected, higher inflation.
Announcements can be made credible in various ways. One is to establish an independent central bank with low inflation targets (but no output targets). Hence, private agents know that inflation will be low because it is set by an independent body.