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The Debate over Monetary and Fiscal Policy

The love of money is the root of all evil.
T H E N EW TE STA ME NT

Lack of money is the root of all evil.

GEORGE BERNA RD SHAW

p to now, our discussion of stabilization policy has been almost entirely objective and technical. In seeking to understand how the national economy works and how government policies affect it, we have mostly ignored the intense economic and political controversies that surround the actual conduct of monetary and fiscal policy. Chapters 14 through 16 are precisely about these issues. We begin this chapter by introducing an alternative theory of how monetary policy affects the economy, known as monetarism. Although the monetarist and Keynesian theories seem to contradict one another, we will see that the conflict is more apparent than real. However, important differences do arise among economists over the appropriate design and execution of monetary policy. These differences are the central concern of the chapter. We will learn about the continuing debates over the nature of aggregate supply, over the relative virtues of monetary versus fiscal policy, and over whether the Federal Reserve should try to control the money stock or interest rates. As we will see, the resolution of these issues is crucial to the proper conduct of stabilization policy and, indeed, to the decision of whether the government should try to stabilize the economy at all.

C O N T E N T S
ISSUE: SHOULD WE FORSAKE STABILIZATION

POLICY?
VELOCITY AND THE QUANTITY THEORY OF MONEY
Some Determinants of Velocity Monetarism: The Quantity Theory Modernized

DEBATE: SHOULD WE RELY ON FISCAL OR MONETARY POLICY? DEBATE: SHOULD THE FED CONTROL THE MONEY SUPPLY OR INTEREST RATES?
Two Imperfect Alternatives What Has the Fed Actually Done?

DIMENSIONS OF THE RULES-VERSUSDISCRETION DEBATE

How Fast Does the Economys Self-Correcting Mechanism Work? How Long Are the Lags in Stabilization Policy? How Accurate Are Economic Forecasts? The Size of Government Uncertainties Caused by Government Policy A Political Business Cycle?

FISCAL POLICY, INTEREST RATES, AND VELOCITY

Application: The Multiplier Formula Revisited Application: The Government Budget and Investment

DEBATE: THE SHAPE OF THE AGGREGATE SUPPLY CURVE DEBATE: SHOULD THE GOVERNMENT INTERVENE?
Lags and the Rules-versus-Discretion Debate

ISSUE REVISITED: WHAT SHOULD BE DONE?

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