Worth: Mankiw Economics 5e CHAPTER 14 Stabilization Policy 381 preceding chapters In this chapter we ask two questions that arise in this debate. First, should monetary and fiscal policy take an active role in trying to stabilize the economy, or should policy remain passive? Second, should policymakers be free to use their discretion in responding to changing economic conditions, or should they be committed to following a fixed policy rule 74-1 Should Policy Be Active or Passive? Policymakers in the federal government view economic stabilization as one of their primary responsibilities. The analysis of macroeconomic policy is a regula duty of the Council of Economic Advisers, the Congressional Budget Office, the Federal Reserve, and other government agencies. When Congress or the presi dent is considering a major change in fiscal policy, or when the Federal Reserve is considering a major change in monetary policy, foremost in the discussion are how the change will influence inflation and unemployment and whether aggre demand needs to be stimulated or restrained Although the government has long conducted monetary and fiscal policy, the view that it should use these policy instruments to try to stabilize the economy is more recent. The Employment Act of 1946 was a key piece of legislation in which the government first held itself accountable for macroeconomic perfor mance. The act states that "it is the continuing policy and responsibility of the Federal Government to .. promote full employment and production. "This law was written when the memory of the Great Depression was still fresh. The law- makers who wrote it believed, as many economists do, that in the absence of an active government role in the economy, events such as the great Depression could occur regularly. To many economists the case for active government policy is clear and simple. Recessions are periods of high unemployment, low incomes, and increased eco- nomic hardship. The model of aggregate demand and aggregate supply shows how shocks to the economy can cause recessions. It also shows how monetary and fis- cal policy can prevent recessions by responding to these shocks. These economists consider it wasteful not to use these policy instruments to stabilize the economy. Dther economists are critical of the governments attempts to stabilize the economy. These critics argue that the government should take a hands-off ap- proach to macroeconomic policy. At first, this view might seem surprising. If our model shows how to prevent or reduce the severity of recessions, why do these critics want the government to refrain from using monetary and fiscal policy for economic stabilization? To find out, let's consider some of their arguments Lags in the Implementation and Effects of policies Economic stabilization would be easy if the effects of policy were immediate Making policy would be like driving a car: policymakers would simply adjust heir instruments to keep the economy on the desired path User JoENA: Job EFFo1430: 6264_ch14: Pg 381: 27867#/eps at 100s Mon,Feb18,20021:024MUser JOEWA:Job EFF01430:6264_ch14:Pg 381:27867#/eps at 100% *27867* Mon, Feb 18, 2002 1:02 AM preceding chapters. In this chapter we ask two questions that arise in this debate. First, should monetary and fiscal policy take an active role in trying to stabilize the economy, or should policy remain passive? Second, should policymakers be free to use their discretion in responding to changing economic conditions, or should they be committed to following a fixed policy rule? 14-1 Should Policy Be Active or Passive? Policymakers in the federal government view economic stabilization as one of their primary responsibilities.The analysis of macroeconomic policy is a regular duty of the Council of Economic Advisers, the Congressional Budget Office, the Federal Reserve, and other government agencies.When Congress or the presi￾dent is considering a major change in fiscal policy, or when the Federal Reserve is considering a major change in monetary policy, foremost in the discussion are how the change will influence inflation and unemployment and whether aggre￾gate demand needs to be stimulated or restrained. Although the government has long conducted monetary and fiscal policy, the view that it should use these policy instruments to try to stabilize the economy is more recent. The Employment Act of 1946 was a key piece of legislation in which the government first held itself accountable for macroeconomic perfor￾mance.The act states that “it is the continuing policy and responsibility of the Federal Government to . . . promote full employment and production.’’This law was written when the memory of the Great Depression was still fresh.The law￾makers who wrote it believed, as many economists do, that in the absence of an active government role in the economy, events such as the Great Depression could occur regularly. To many economists the case for active government policy is clear and simple. Recessions are periods of high unemployment, low incomes, and increased eco￾nomic hardship.The model of aggregate demand and aggregate supply shows how shocks to the economy can cause recessions. It also shows how monetary and fis￾cal policy can prevent recessions by responding to these shocks.These economists consider it wasteful not to use these policy instruments to stabilize the economy. Other economists are critical of the government’s attempts to stabilize the economy. These critics argue that the government should take a hands-off ap￾proach to macroeconomic policy.At first, this view might seem surprising. If our model shows how to prevent or reduce the severity of recessions, why do these critics want the government to refrain from using monetary and fiscal policy for economic stabilization? To find out, let’s consider some of their arguments. Lags in the Implementation and Effects of Policies Economic stabilization would be easy if the effects of policy were immediate. Making policy would be like driving a car: policymakers would simply adjust their instruments to keep the economy on the desired path. CHAPTER 14 Stabilization Policy | 381