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Chapter Review Chapter 38: Controversies in Macroeconomics

  1. The traditional view of government deficits argues that deficits reduce national saving, raise the equilibrium real interest rate, and crowd out private investment spending. The result is less capital and lower incomes in the future. The burden of government deficits falls on future generations.
  2. Under Ricardian equivalence, individuals understand that deficits today mean higher taxes in the future. Those in the private sector increase their saving in anticipation of the higher future taxes. Thus, national saving does not fall and deficits do not matter.
  3. Those who criticize active policy intervention to stabilize the economy argue that markets adjust quickly, making unemployment only short-lived. Attempts by government to intervene are not only unnecessary but largely ineffective, since they are offset by actions of the private sector. And to the extent that they do have effects, such policies often exacerbate fluctuations, because there are long lags, because the government has limited information, and because political pressures lead it to overheat the economy before elections.
  4. Critics of discretionary policy believe that the government should tie its hands by using fixed rules. Discre¬ tionary policies may be inconsistent over time, leading to worse outcomes than occur when government follows predictable rules. Critics of fixed rules argue that by embracing them government gives up an important set of instruments and that fixed rules never work well because they fail to respond to the ever-changing structure of the economy.
  5. The proponents of inflation targeting in the United States argue that it will make the Fed more accountable, increase the credibility of the Fed’s low inflation policy, and institutionalize good policies.
  6. Opponents of inflation targeting argue that it elevates one goal of monetary policy at the expense of other goals, limits Fed flexibility, and is unnecessary.
  7. Aggregate supply shocks require policymakers to balance the goals of full employment and stable inflation. To achieve one goal, the other must be sacrificed. Aggregate demand shocks create no inherent conflict between these goals.
  8. Disturbances such as oil price changes or shifts in inflationary expectations force policymakers to face a trade-off between stabilizing unemployment and stabilizing inflation. If the central bank adjusts interest rates more aggressively to changes in inflation, it can make inflation more stable, but output and employment will fluctuate more.
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