Page 399 - Krugmans Economics for AP Text Book_Neat

that tax cuts and spending increases are at least somewhat effective in increasing aggre-
gate demand.
Many, but not all, macroeconomists, believe that discretionary fiscal policy is usually
counterproductive: the lags in adjusting fiscal policy mean that, all too often, policies
intended to fight a slump end up intensifying a boom.
As a result, the macroeconomic consensus gives monetary policy the lead role in eco-
nomic stabilization. Discretionary fiscal policy plays the leading role only in special cir-
cumstances when monetary policy is ineffective, such as those facing Japan during the
1990s when interest rates were at or near the zero bound and the economy was in a liq-
uidity trap.

Should Monetary Policy Be Used in a Section 6 Inflation, Unemployment, and Stabilization Policies
Discretionary Way?

Classical macroeconomists didn’t think that monetary policy should be used to fight
recessions; Keynesian economists didn’t oppose discretionary monetary policy, but
they were skeptical about its effectiveness. Monetarists argued that discretionary mon-
etary policy was doing more harm than good. Where are we today? This remains an
area of dispute. Today there is a broad consensus among macroeconomists on these
points:
■ Monetary policy should play the main role in stabilization policy.
■ The central bank should be independent, insulated from political pressures, in
order to avoid a political business cycle.
■ Discretionary fiscal policy should be used sparingly, both because of policy lags and
because of the risks of a political business cycle.
There are, however, debates over how the central bank should set its policy.
Should the central bank be given a simple, clearly defined target for its policies, or

fyi

Supply -Side Economics
During the 1970s, a group of economic writers curve, a hypothetical relationship between tax new classical macroeconomics. But unlike ra-
began propounding a view of economic policy rates and total tax revenue that slopes upward tional expectations and real business cycle
that came to be known as “supply - side eco- (meaning higher taxes bring higher tax rev- theory, supply - side economics is generally dis-
nomics.” The core of this view was the belief enues) at low tax rates but turns downward missed by economic researchers.
that reducing tax rates, and so increasing the (meaning higher taxes bring lower tax revenues) The main reason for this dismissal is lack of
incentives to work and invest, would have a when tax rates are very high. evidence. Almost all economists agree that tax
powerful positive effect on the growth rate of In the 1970s, supply - side economics cuts increase incentives to work and invest, but
potential output. The supply - siders urged the was enthusiastically supported by the editors attempts to estimate these incentive effects in-
government to cut taxes without worrying about of the Wall Street Journal and other figures dicate that at current U.S. tax levels they aren’t
matching spending cuts: economic growth, they in the media, and it became popular with nearly strong enough to support the strong
argued, would offset any negative effects from politicians. In 1980, Ronald Reagan made claims made by supply - siders. In particular, the
budget deficits. Some supply - siders even ar- supply - side economics the basis of his supply - side doctrine implies that large tax cuts,
gued that a cut in tax rates would have such a presidential campaign. such as those implemented by Ronald Reagan
miraculous effect on economic growth that tax Because supply - side economics emphasizes in the early 1980s, should sharply raise poten-
revenues—the total amount taxpayers pay to supply rather than demand, and because the tial output. Yet estimates of potential output by
the government—would actually rise. That is, supply - siders themselves are harshly critical the Congressional Budget Office and others
some supply - siders argued that the United of Keynesian economics, it might seem as if show no sign of an acceleration in growth after
States was on the wrong side of the Laffer supply - side theory belongs in our discussion of the Reagan tax cuts.

module 36 The Moder n Macroeconomic Consensus 357