Macroeconomics Study Set 62

Answer:

Lags in stabilization policy
Lags in stabilization policy refer to the time delay, that is, the time difference between the execution of the stabilization policy and its impacts on the economy.
Stabilization policy aims at stabilizing the economic fluctuations, that is, boom and recession.
Time lags in stabilization policy destabilize the economy
If there is a recession, then the expansionary stabilization policy has taken more time to have an impact on the business cycle contraction due to time lag issues. When the policy starts working, the economy itself begins with the recovery stage. Therefore, the stabilization policy speeds up the economy growth, which leads to inflation.
On the other hand, if there is a higher inflation, then the contractionary policy to stabilize the economy has taken more time to have an impact on the inflation, which arises due to business cycle expansion. Before the policy starts working, the economic forces itself brings down the aggregate demand, which in turn leads to recession stage. Therefore, the stabilization policy speeds up the negative economic growth, which leads to depression.
Hence, the time lags in the policy execution cause destabilization.

Answer:

Flat aggregate supply curve
The change in level of money supply leads to a change in the price level.
When the aggregate supply curve is much more flat, then the small increase in the price level leads to an increase in the output and employment more than the increase in the price level. Therefore, the small cost of inflation will gain more output and employment.
Hence, the expansionary fiscal or monetary policy is more effective if the aggregate supply curve is flatter.
On the other hand, a small decrease in the price level causes large reduction in the output and employment. Therefore, the huge cost of output and employment controls the small level of inflation. Hence, the contractionary monetary or fiscal policy is not effective if the aggregate supply curve is flatter.
Thus, the economists who believe that supply curve is flatter suggest expansionary policy since it is more effective in increasing the employment without much increase in the price level.
Steep aggregate supply curve
When the supply curve is steep, then the higher increase in the price level causes fewer increases in the output and employment. Therefore, the higher cost of inflation will gain fewer amount of output and employment. Hence, the expansionary fiscal or monetary policy is not effective if the aggregate supply curve is steeper.
On the other hand, the higher reduction in the price level causes fewer decreases in the output and employment. Therefore, contractionary monetary or fiscal policy is controlling higher level of inflation at the cost of fewer output and employment. Hence, contractionary monetary or fiscal policy is much more effective if the aggregate supply curve is steeper.
Thus, the economists who believe that supply curve is steeper suggest contractionary policy since it is more effective in decreasing the inflation.

Answer:

Discretionary policy
Discretionary policy refers to the policy which is implemented based on the trial and error method. This policy does not support any theory and involves the expectations of the policymakers. This policy is used at times when the economy is not responding according to the fixed rules policy, which leads to failure in achieving its goal.
Rules
Rules refer to the policy that is already designed for achieving the economic goals. This does not consider the present economic situation. This policy is used at times when the economy responds well according to the fixed rules policy, which leads to achievement of its goal.
Self-correcting mechanism
When the structural changes make the economy's self-correcting mechanism work more quickly and reliably, then the economy is responding with the fixed rules. Hence, this strengthens the arguments for rules.
b. Finding new statistical method
The finding of new statistical method that improves economic forecasting will serve to identify the efficient stabilization policy by trial and error method. Hence, this strengthens the arguments for discretionary policy.
c. Republican congress and democratic president
If a republican is elected when there is a democratic president, then a different policy will be proposed by each party. This will lead to destabilization due to the involvement of time lag. If both parties implement the rules, then this will avoid the time lag. Hence, this strengthens the arguments for rules.