Five Debates About

Macroeconomic Policy
(Pros and Cons)
1. Should monetary and fiscal policymakers try to stabilize the
economy?
2. Should monetary policy be made by rule rather than by
discretion?
3. Should the Central Bank aim for zero inflation?
4. Should fiscal policymakers reduce the government debt?
5. Should the tax laws be reformed to encourage saving?
1. Should monetary and fiscal
policymakers try to stabilize the economy?
Pros
• The economy is inherently unstable, and left on its own will fluctuate.
• Policy can manage aggregate demand in order to offset this inherent
instability and reduce the severity of economic fluctuations.
• There is no reason for society to suffer through the booms and busts of
the business cycle.
• Monetary and fiscal policy can stabilize aggregate demand and,
thereby, production and employment.
Cons
• Monetary policy affects the economy with long and unpredictable lags
between the need to act and the time that it takes for these policies to work.
• Many studies indicate that changes in monetary policy have little effect on
aggregate demand until about six months after the change is made.
• Fiscal policy works with a lag because of the long political process that
governs changes in spending and taxes.
• It can take years to propose, pass, and implement a major change in fiscal
policy.
• All too often policymakers can inadvertently exacerbate rather than mitigate
the magnitude of economic fluctuations.
• It might be desirable if policy makers could eliminate all economic
fluctuations, but this is not a realistic goal.
2. Should monetary policy be made by rule
rather than by discretion?
Pros
• Discretionary monetary policy can suffer from incompetence and abuse of power.
• To the extent that central bankers ally themselves with politicians, discretionary
policy can lead to economic fluctuations that reflect the electoral calendar – the
political business cycle.
• There may be a discrepancy between what policymakers say they will do and
what they actually do – called time inconsistency of policy.
• Because policymakers are so often time inconsistent, people are skeptical when
central bankers announce their intentions to reduce the rate of inflation.
• Committing the Central Bank to a moderate and steady growth of the money
supply would limit incompetence, abuse of power, and time inconsistency.
Cons
• An important advantage of discretionary monetary policy is its
flexibility.
• Inflexible policies will limit the ability of policymakers to respond to
changing economic circumstances.
• The alleged problems with discretion and abuse of power are largely
hypothetical.
• Also, the importance of the political business cycle is far from clear.
3. Should the Central Bank aim for zero
inflation?
Pros
• Inflation confers no benefit to society, but it imposes several real costs.
• Shoeleather costs
• Menu costs
• Increased variability of relative prices
• Unintended changes in tax liabilities
• Confusion and inconvenience
• Arbitrary redistribution of wealth
• Reducing inflation is a policy with temporary costs and permanent benefits.
• Once the disinflationary recession is over, the benefits of zero inflation
would persist.
Cons
• Zero inflation is probably unattainable, and to get there involves
output, unemployment, and social costs that are too high.
• Policymakers can reduce many of the costs of inflation without
actually reducing inflation.
4. Should fiscal policymakers reduce the
government debt?
Pros
• Budget deficits impose an unjustifiable burden on future generations
by raising their taxes and lowering their incomes.
• When the debts and accumulated interest come due, future taxpayers
will face a difficult choice:
• They can pay higher taxes, enjoy less government spending, or both.
• By shifting the cost of current government benefits to future
generations, there is a bias against future taxpayers.
• Deficits reduce national saving, leading to a smaller stock of capital,
which reduces productivity and growth.
Cons
• The problem with the deficit is often exaggerated.
• The transfer of debt to the future may be justified because some
government purchases produce benefits well into the future.
• The government debt can continue to rise because population growth
and technological progress increase the nation’s ability to pay the
interest on the debt.
5. Should the tax laws be reformed to encourage saving?

Pros
• A nation’s saving rate is a key determinant of its long-run economic prosperity.
• A nation’s productive capability is determined largely by how much it saves and invests for
the future.
• When the saving rate is higher, more resources are available for investment in new plant and
equipment.
• The tax system discourages saving in many ways, such as by heavily taxing the income from
capital and by reducing benefits for those who have accumulated wealth.
• The consequences of high capital income tax policies are reduced saving, reduced capital
accumulation, lower labor productivity, and reduced economic growth.
• An alternative to current tax policies advocated by many economists is a consumption tax.
• With a consumption tax, a household pays taxes based on what it spends not on what it earns.
• Income that is saved is exempt from taxation until the saving is later withdrawn and spent on
consumption goods.
Cons
• Many of the changes in tax laws to stimulate saving would primarily
benefit the wealthy.
• High-income households save a higher fraction of their income than low-income
households.
• Any tax change that favors people who save will also tend to favor people with
high incomes.
• Reducing the tax burden on the wealthy would lead to a less egalitarian
society.
• This would also force the government to raise the tax burden on the poor.
• Raising public saving by eliminating the government’s budget deficit
would provide a more direct and equitable way to increase national
saving.