Macroeconomic stabilization: views of activists versus non-activists

Agreement: There has been less instability since 1945 than prior to 1940; the objectives should be smaller fluctuations, high employment, growth of output, price stability.

Issue is how to achieve.

2 strategies:

                            Activist                                                 Non-activist

                            Adjust policy to                                      No discretion --

                            reduce instability                                     follow set rules
 
 

Views:

Source of instability: "Shocks" -- economy                             Bad policy often the

                                inherently unstable                                 source of instability

Speed of self-correction: Slow, therefore high cost                 OK if not slowed by bad policy
 

Timing of discretionary policy:

                                Difficult but possible                           Ineffective -- more often wrong than right

Impact of rules          Rules would increase                         Rules would reduce

                                instability                                             instability
 
 

How:                         Use leading indicators,                         Policy ineffective because of

                                    forecasting models, to                         expectations, lags, so set

                                    set policy                                             rules instead of discretion:

                                                                                            for Money supply growth

                                    [or instead use:                                     or Money GDP growth

                                commodity prices or price level

                                or slope of yield curve

                                        or exchange rates]                     [i.e. because of velocity v                                                                                  changes Money supply would have erratic

                                                                                                                effects]
 
 

Note: Differing views reflect differences of opinion both about how the institutions of economic policy making work, and about what the evidence suggests is how the economy itself works. Proponents of rules tend to be suspicious of ability of institutions (Federal Government, Federal Reserve) to act in an unbiassed way.