Macroeconomic Policy: Demystifying Monetary and Fiscal Policy PDF
Preview Macroeconomic Policy: Demystifying Monetary and Fiscal Policy
Macroeconomic Policy Second edition MacroeconomicPolicyisalivelyandinformativeintroductiontothediverse doctrinesofmacroeconomictheory. Prof.RobertE.Lucas,Jr.,Recipientofthe1995NobelPrizeinEconomics ThenotionofallowingthereaderthefreedomofchoicebetweentheKeynesian andSupply-Sidermodelsfordevelopedeconomiesisfreshandradicallydifferent frommostconventionalmacroeconomictexts.Inaddition,itisanhonest approach...giventhatpolicymakers...stillmakepolicybasedonassumptions behindeachparadigm. Dr. W. Michael Cox, Senior Vice President and Chief Economist, Federal Reserve Bank of Dallas,andco-authorofMythsofRichandPoor Farrokh K. Langdana Macroeconomic Policy Demystifying Monetary and Fiscal Policy Second edition Foreword by W. Michael Cox 1 3 FarrokhK.Langdana RutgersBusinessSchool RutgersUniversity Newark,NJ07102 USA [email protected] ISBN978-0-387-77665-1 e-ISBN978-0-387-77666-8 DOI10.1007/978-0-387-77666-8 LibraryofCongressControlNumber: #SpringerScienceþBusinessMedia,LLC2009 Allrightsreserved.Thisworkmaynotbetranslatedorcopiedinwholeorinpartwithoutthewritten permissionofthepublisher(SpringerScienceþBusinessMedia,LLC,233SpringStreet,NewYork, NY10013,USA),exceptforbriefexcerptsinconnectionwithreviewsorscholarlyanalysis.Usein connectionwithanyformofinformationstorageandretrieval,electronicadaptation,computer software,orbysimilarordissimilarmethodologynowknownorhereafterdevelopedisforbidden. Theuseinthispublicationoftradenames,trademarks,servicemarks,andsimilarterms,evenifthey arenotidentifiedassuch,isnottobetakenasanexpressionofopinionastowhetherornottheyare subjecttoproprietaryrights. Printedonacid-freepaper springer.com To my wife, Mary Foreword Macroeconomicpolicyanalysishasbeeninastateoffluxsincetheearly1970s. Althoughthecasualstudentofmacroeconomicsmightexpectthateconomists would have come to some agreement in our quest to model the so-called real world, the analysis of macroeconomic policy has perhaps never been so con- foundingasitistoday.Eachmonetaryorfiscalpolicyeventisalmostinevitably followedbyatleasttwocompletelydifferentandconflictingsetsofanalyses. Consider,forexample,thequestionofwhethergovernmentspendingaffects GDP growth. One can find just about any answer to this question possible— some say it increases GDP, some that it decreases GDP, and some claim no effect.Othersgoontoclaimthattheanswerdependsonwhethertheeconomyis adevelopedone,suchastheUS,oranemergingone,likeChina. AnothercentralsourceofconfusionistheproverbialPhillipsCurve,which, asoriginallyconceived,relatedtheunemploymentratetowageinflation.Some researchershavefoundaninverserelationshipbetweenthesevariables;others have found no link at all. What’s more, the economics profession has intro- ducednewandimprovedvariantsonPhillips’tradeofftheme—inflationversus unemployment rates, inflation versus GDP growth, inflation versus capacity utilization,andsoon.Foreachofthesepostulatedrelationships,virtuallyany conclusion canbe found. And toconfoundthings even more, theconclusions appear able to change over time as the economy changes. The statistical evidence from the much-heralded ‘‘New Economy’’ of the late 1990s seems to suggestthatrapidGDPislinkedmoretolowthanhighinflation.Willthereal Phillipscurverelationshippleasestandup? Conceivably,thereareasmanyinterpretationsofeconomicphenomenonas thereareeconomiststointerpretthem.Allthismaybewellandgoodfromthe standpointofthepassionateresearcher,whomakesalivinginanendlesssearch for the Holy Grail. But for the typical student, less interested in contrast and moreinterestedinconclusions,theresultcanbeastateofconfusionasheorshe movesfromclasstoclass,frombooktobook,orfrompublicationtopublica- tion.Findingthetruthforeconomicsstudentshasbecomeabitofamystery. Enter Farrokh Langdana’s book, aptly titled Macroeconomic Policy: DemystifyingMonetaryandFiscalPolicy.Notonlydoesthebookshineabright light through the dense fog surrounding economists’ centrist position on vii viii Foreword macroeconomicthought,itdoessowithasetoftoolsvirtuallyallreaderscan handle.Thecumbersomemathematicsthatmostmoderneconomistslovebut moststudentsloathe,areputasideinfavorofteachingtoolswithwiderappeal. Even economists have recognized that as our profession has aged, our language—both verbal and quantitative—has become more convenient and precise for us, but less accessible and attractive to the general audience. So, whatshouldtheeconomicsprofessordo?EconomistFrancisEdgeworth,writ- ingnearlyacenturyagoaboutAlfredMarshall,oneofeconomics’originaland first-classmathematicians,saidthat‘‘Marshall,whodesiredaboveallthingsto beuseful,deferredtotheprejudicesofthosethathewishedtopersuade(emphasis added).’’Inotherwords,weshouldspeakinthelanguageofouraudience,not ourprofession.Increasingly,theeconomicsprofessionshunsthiscommunica- tion principle in favor of ‘‘rigor,’’ all the while knowing that, as economist Robert Heilbroner said, ‘‘Mathematics has given economics rigor, but alas, alsomortis.’’ The Bureau of Labor Statistics estimates that there are roughly 135,000 economistsintheUSoutofapopulationofroughly287million.Thisfigures outtobe1economistforevery2,126people.Mustnotitbeimportanttospeak totheother2,125,notjusttotheone?Ofcourse,andthusthisbookiswritten foryou,notforeconomists. When Richard Alm and I wrote Myths of Rich and Poor, we set out to debunk a series of widely accepted myths that the US was lagging behind economically, and that its citizens were getting progressively worse off. We accomplishedthecompletedismantlingofsuchmythsbypresentingsystematic overwhelming evidence that the US has been prospering splendidly in recent decades,andwedidsousingtheonlytoolpossibleforsuchalargeaudience— common sense. The reaction to our book has been tremendous because we spokeeyetoeyewithfolks,notabovetheirheads. MacroeconomicPolicy:DemystifyingMonetaryandFiscalPolicytakeson an equally important task—to show the reader that modern macroeconomic analysisissystematic,withlogicalframeworkswithinwhicheconomiescanbe successfullyanalyzed,andtodothiswithouttheuseofoverlyfancytechniques. The applied and intuitive approach to the theory centers on diagrammatic derivations, using only the minimal techniques necessary to prove its points. Whilethebookapproachesanalysisprimarilyviaapplicationsandanalysis,the vitaltheoreticalunderpinningshavenotbeensacrificed. As a long-time professor of economics, a practicing economist and an author,theteachingapproachthatIfindmostcompellingisthe‘‘applications method.’’Beginwithanimportantissue(suchassupplysideeconomics)atleast vaguelyfamiliartojustaboutanybody,setoutthecentralopposingviewswith the intuition behind each side, then examine the evidence and thrash out the conclusion. That’s the best teaching approach because that’s the way people thinkandwork. AndthusitiswithProfessorLangdana’sbook,wehaveatextthatisfirstand foremostapplicationsoriented.That’swhyMBAandExecutiveMBAstudents Foreword ix willfindthisbookindispensable,financialanalystsmayliketohaveitonhand asanessentialreference,andevenageneralaudiencecanfindituseful. Theoverviewchapterclearlyandconciselystatesthebook’spositionregard- ingitsfocusonintuitionandapplicability.Thenotionofallowingthereaderthe freedom of choice between the Keynesian or the Supply-Side paradigm for developed economies is fresh and radically different from most conventional macroeconomics texts. In addition, it is an honest approach, given that both monetaryandfiscalpolicymakersinWashingtonD.C.stillmakepolicybased onassumptionsbehindeachparadigm. Theauthorstatesthathehastakencarenottoinfluencethereadertowards eitherparadigmandhehasfaithfullymanagedtokeepthepromisethroughout the text. The coverage is carefully balanced, with the excellent chapter on the New Economy (Chapter 10) being especially pertinent to the two-model approach.Inthechapteronmonetarypolicy(Chapter11),FarrokhLangdana and Giles Mellon actually discuss the fact that reserve requirements are not bindinganymoreintheUnitedStates.Thisisoneofveryfewtextsthathave managed to cogently explain how the conventional textbook explanation of openmarketoperationsandthe‘‘moneymultiplier’’hassubstantiallychanged inseveralmajoreconomies. The simulated ‘‘media articles’’ following each chapter are vital to this text and to truly analyzing macroeconomic policy in general. It rapidly becomes evidentthroughtheclarityofexpositionwhytheauthorhasbeenconsistently ratedsohighlyasateacher. FederalReserveBankofDallas W.MichaelCox Dallas,TX,USA Dr.W.MichaelCoxisSeniorVicePresidentandChiefEconomistattheFederal ReserveBankofDallas,ProfessorofEconomicsatSouthernMethodistUniver- sity,andco-author(withRichardAlm)ofthehighlyacclaimedMythsofRichand Poor:WhyWe’reBetterOffThanWeThink(nominatedforaPulitzerPrize).He is a regular contributing columnist for Investor’s Business Daily. In addition to beingafrequentguestonCNN,VoiceofAmericaandNationalPublicRadio,Dr. CoxispastPresidentoftheAssociationofPrivateEnterpriseEducation,aCATO InstituteAdjunctScholar,seniorfellowattheNationalCenterforPolicyAnaly- sis, and senior fellow at the Dallas Fed’s Globalization and Monetary Policy Institute. Acknowledgments This book would, quite simply, not have been possible without the assistance andencouragementofmanypeople. IbeginbythankingProf.RobertE.LucasoftheUniversityofChicago,the recipientofthe1995NobelPrizeinEconomics,forhiscommentsandsugges- tions pertaining to my experimental testing of his paradigm-busting ‘‘islands’’ model(Chapter10).Prof.Lucas’workhasbeenasourceofencouragementand inspiration to me as well as to generations of macroeconomists over the last threedecades. Dr.MichaelCox,ChiefEconomistandSeniorVicePresidentoftheFederal ReserveBankofDallas,andco-authorofMythsofRichandPoor:WhyWeAre Better Off Than We Think, took time off from his busy schedule to write the forewordforthisbook,andforthatIammostgrateful.Dr.Cox,whoisalso ProfessorofEconomicsatSouthernMethodistUniversity,hasdrawnuponhis experience as economist, professor, and author to eloquently describe the challengesfacedinanalyzingaswellasteachingmacroeconomicpolicytoday. Inafewshortpages,hehasdeftlymanagedtohome-inontheveryessenceof thebook. IremainextremelygratefultomyformercolleagueProfessorGilesMellonat Rutgers Business School with whom I co-authored most recently, ‘‘Monetary PolicyinaWorldofNon-BindingReserveRequirements.’’IthankGilesforhis invaluableassistancewithChapter11inwhichwe‘‘blowthewhistle’’onthefact that,inreality,centralbankopenmarketoperationsinmostdevelopedecono- mieshaveverylittleincommonwithconventionaltextbookdiscussionsonthe subject. Iamindebtedtomyco-authoroftwobooks(andawell-receivedpaperon Confederate financing in the US Civil War), Prof. Richard C.K. Burdekin of Claremont McKenna College and Claremont Graduate School, for his com- ments,suggestions,anddetailedstructuraladvicerelatedtothedraftofthefirst proposal.ThanksalsotoProfessorsMarkCastelino,LeonardGoodman,and Menahem Spiegel for their extremely valuable comments that enabled the proposaltoevolveintothefirstdraft. IamverygratefultomyExecutiveVice-Dean,Prof.RosaOppenheim,for herextremelyusefulsuggestionspertainingtotheorganizationandcontentof xi
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