Dynamic Macroeconomics
Monetary and Fiscal Policy with a Full Employment Target
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9-MAVZUGA (KEYNS MODELI VA FILLIPS EGRI CHIZIG\'I) (1)
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- 15.3.3 Monetary and Fiscal Policy with a Full Employment Target and a Price Level Target
15.3.2 Monetary and Fiscal Policy with a Full Employment Target
Let us assume that the sole target of macroeconomic policy is to maintain output at its full employment level. This can be done by using either fiscal policy, monetary policy, or both to ensure that aggregate demand is equal to full employment output y f . From (15.26) and (15.28) , output and the price level satisfy Using (15.30) to substitute for the price level in (15.29) , we get From (15.31) , we see that the government can use its aggregate demand instruments (i.e., m and g) to achieve the target of full employment output. If m and g satisfy (15.31) for all periods, then output will always be at its full employment target under the discretionary policy. If the monetary instrument of the government is the nominal interest rate and not the money supply, then (15.31) would be replaced by The money supply would then become endogenous, and the price level would still be determined by (15.30) . The above analysis is the justification for discretionary aggregate demand policies in the Keynesian model. In principle, aggregate demand policies can be used to counteract the effects of both demand and supply shocks on aggregate output and unemployment. This ability would imply that aggregate demand policies could in principle be used to stabilize economic activity at the level of full employment and help avoid the repetition of phenomena such as the Great Depression. 15.3.3 Monetary and Fiscal Policy with a Full Employment Target and a Price Level Target From the preceding analysis, note that if output is stabilized at its full employment level, then the price level cannot be controlled and depends only on the exogenous nominal wage and aggregate supply shocks through equation (15.30) . If the government wanted to achieve a price level target as well as full employment, it would not be able to do so, as its monetary and fiscal policy instruments both operate through aggregate demand and are thus linearly dependent. Effectively, the government has only one instrument, aggregate demand policy, and thus can only achieve one target. To affect the price level, it would need an independent instrument (such as an incomes policy) that would affect the nominal wage in (15.30) . Without such an additional instrument, it would have to balance deviations from the full employment target against deviations from the price level target. Let us assume, following Theil [1964], that the government selects monetary and fiscal policy to minimize a loss function that depends on quadratic deviations of output from full employment output and the price level from a socially desirable fixed price level target. This loss function takes the form where is the price level target, and ζ measures the relative marginal social cost of price deviations relative to output deviations in the social welfare ranking of the government. 18 The problem of discretionary economic policy can be modeled as the minimization of the welfare loss (15.33) , subject to the constraint of the model of the economy described by equations (15.26) – (15.28) . The outcome of such a policy process is often described as discretionary policy, because the government chooses its policy instruments in every period to minimize its one-period loss function. From the first-order conditions for a minimum, it follows that At the optimum, the government aggregate demand policies equate the marginal social cost of deviations of output from full employment to the marginal welfare cost of deviations of the price level from its target. If the government possessed enough instruments to eliminate deviations of both output from its full employment level and the price level from its target, then (15.34) would be satisfied for zero deviations from the targets of the government. However, the government essentially has one policy instrument, as both monetary and fiscal policy operate through aggregate demand. Using the aggregate supply function (15.26) to substitute for y − y f in (15.34) , we find that under the optimal policy, The price level will deviate from the government’s target under the optimal policy, unless there is a “divine coincidence,” which ensures that the exogenous nominal wage, the price level target of the government, and the supply shock are such that the right-hand side of (15.35) adds up to zero. Aggregate demand policies do not affect (15.35) . Substituting (15.35) in (15.34) , we can see that under the optimal policy, output will also deviate from full employment output, and the deviation is determined by Supply shocks will cause positive deviations of output from full employment output, and wage shocks will cause negative deviations of output from full employment output. The lower the price level target of the government relative to the nominal wage is, the smaller the deviation of output from full employment output will be: Thus, a government with a low price level target, given nominal wages, will end up with lower output and employment compared to full employment under the optimal discretionary policy. In the presence of wage and supply shocks, discretionary aggregate demand policies can only ensure that the deviation of output from full employment output satisfies (15.34) , but no more. Wage and supply shocks induce a trade-off between the employment and price level target of a government. Full employment is not compatible with the optimal discretionary macroeconomic policy, because the government has one instrument (aggregate demand policies) but two targets (output and the price level). The optimal discretionary policy is thus second best, as the government just balances, at the margin, the welfare costs associated with deviations of the price level and output from its targets. From (15.34) , note that if ζ = 0 (i.e., if the government cares only about output and not the price level), this trade-off disappears, and we are back to a full employment equilibrium, as analyzed in sub-section 15.3.2. However, in such a case, the price level is destabilized. The problem is that monetary and fiscal policy in Keynesian models (such as the AD-AS model we analyzed) can only affect aggregate demand. It is optimal to use them to achieve full employment only if the government cares about output and employment and not the price level. If the government cares about both output and the price level, achieving full employment through discretionary aggregate demand policies is not feasible in the presence of wage and supply shocks, because the optimal policy is second best. The government does not have enough instruments to achieve both targets. Thus, under the optimal discretionary aggregate demand policy, the best a government could do is to equalize the marginal welfare cost of deviations of output from full employment to the marginal welfare cost of deviations of the price level from its target, as suggested by (15.34) . If the government is to be able to achieve both of its targets fully under the discretionary policy, it needs another policy instrument in addition to monetary and fiscal policies. Such an instrument could, for instance, be a price or incomes policy that would operate through controls of nominal wages or prices. Note from (15.35) and (15.36) that if a government could control nominal wages, then it would be able to achieve both full employment and the price level target. From the 1950s to the 1970s, when many governments tried to implement discretionary aggregate demand policies, conflicts often arose between the targets of full employment and price stability. In such cases, many governments resorted to nominal wage and price controls as an additional policy instrument that would help resolve the conflicts. These conflicts became even more acute with the negative supply shocks of the 1970s, which led to stagflation, a combination of recession with a rise in inflation. We shall return to the dilemma of rules versus discretion after we discuss the evolution of Keynesian models since the 1960s, following the emergence of the Phillips curve. Download 0.91 Mb. Do'stlaringiz bilan baham: |
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