Page 772 - The Principle of Economics

794 PART THIRTEEN
FINAL THOUGHTS
exacerbate rather than mitigate the magnitude of economic fluctuations. Some economists have claimed that many of the major economic fluctuations in history, including the Great Depression of the 1930s, can be traced to destabilizing policy actions.
One of the first rules taught to physicians is “do no harm.” The human body has natural restorative powers. Confronted with a sick patient and an uncertain diagnosis, often a doctor should do nothing but leave the patient’s body to its own devices. Intervening in the absence of reliable knowledge merely risks making matters worse.
The same can be said about treating an ailing economy. It might be desirable if policymakers could eliminate all economic fluctuations, but that is not a realistic goal given the limits of macroeconomic knowledge and the inherent un- predictability of world events. Economic policymakers should refrain from inter- vening often with monetary and fiscal policy and be content if they do no harm.
QUICK QUIZ: Explain why monetary and fiscal policy work with a lag. Why do these lags matter in the choice between active and passive policy?
SHOULD MONETARY POLICY BE MADE BY RULE RATHER THAN BY DISCRETION?
As we first discussed in Chapter 27, the Federal Open Market Committee sets monetary policy in the United States. The committee meets about every six weeks to evaluate the state of the economy. Based on this evaluation and fore- casts of future economic conditions, it chooses whether to raise, lower, or leave un- changed the level of short-term interest rates. The Fed then adjusts the money supply to reach that interest-rate target until the next meeting, when the target is reevaluated.
The Federal Open Market Committee operates with almost complete discre- tion over how to conduct monetary policy. The laws that created the Fed give the institution only vague recommendations about what goals it should pursue. And they do not tell the Fed how to pursue whatever goals it might choose. Once mem- bers are appointed to the Federal Open Market Committee, they have little man- date but to “do the right thing.”
Some economists are critical of this institutional design. Our second debate over macroeconomic policy, therefore, focuses on whether the Federal Reserve should have its discretionary powers reduced and, instead, be committed to fol- lowing a rule for how it conducts monetary policy.
PRO: MONETARY POLICY SHOULD BE MADE BY RULE
Discretion in the conduct of monetary policy has two problems. The first is that it does not limit incompetence and abuse of power. When the government sends