Reed College
Reed College

Economics 341

Monetary and Fiscal Policy
Fall 2019
Jeffrey Parker
Course Outline and Reading List

All readings are required unless otherwise noted. Links are provided to most of the journal articles. Books are generally on print reserve in the library.

Go to this week's reading

I. An Overview of Monetary and Fiscal Policy

Session 1 (September 4): Introduction to Econ 341

Key Questions
  • What is this class about?
  • What are the requirements?
Readings
  • None

Session 2 (September 6):  Basic Macroeconomic Framework I 

Key Questions
  • Why is the "real value of money" the reciprocal of the aggregate price level? How does that underpin the classical principle that the aggregate price level depends on the demand for and supply of money?
  • What could cause an increase in monetary velocity? According to the classical quantity theory, what would happen to aggregate prices and to real output if this happened (holding the money supply fixed) and why?
  • In the simple Keynesian income-expenditure model, what determines the volume of real output? Does this seem more appropriate in the short run or long run? Why?
  • What does the marginal propensity to consume measure? What does the Keynesian expenditure multiplier measure? Why does a higher MPC lead to a higher multiplier?
Readings

Session 3 (September 9):  Basic Macroeconomic Framework II 

Key Questions
  • What is true of the values of r and Y on the IS curve that is not true of other values? Why does the IS curve slope downward?
  • What is true of the values of r and Y on the LM curve that is not true of other values? Why does the LM curve slope upward?
  • Describe two exogenous changes that would shift the IS curve to the right. Other things equal, what would happen to the equilibrium values of output and the real interest rate?
  • Describe two exogenous changes that would shift the LM curve to the right. Other things equal, what would happen to the equilibrium values of output and the real interest rate?
Readings

Session 4 (September 11):  Basic Macroeconomic Framework III 

Key Questions
  • Why is the aggregate-supply curve vertical in the long run?
  • Why does the aggregate-supply curve slope upward in the short run?
  • Why does the aggregate-demand curve slope downward? What monetary and fiscal policy variables cause it to shift to the right? What will be the short-run and long-run effects of such a shift on real output and the price level?
  • If real output is growing at 2% and the money supply is increasing at 5%, what would you expect the long-run inflation rate to be? Why?
Readings

Session 5 (September 13): Introduction to Central Issues in Monetary and Fiscal Policy

Key Questions
  • Why can't the central bank simply target real output (or inflation) rather than choosing an intermediate instrument such as the money supply or an interest rate?
  • The Federal Reserve System in the United States has a "dual mandate" to influence both employment/output and prices/inflation. Which of these goals is more relevant to the short run and which to the long run? In what situations would they indicate conflicting actions for the central bank?
  • Briefly sketch the sequence of events that must occur before an expansionary monetary-policy action causes an increase in spending. Which linkages seem likely to lead to significant monetary-policy lags?
  • Define "automatic stabilizers" and give two examples. How would a simple balanced-budget rule (such as the one in place for most state and local governments) affect the effectiveness of automatic stabilizers?
Readings
  • Parker, Jeffrey. Economics 314 Coursebook, 2019 edition, Chapter 17 "Monetary Policy," Section B, and Chapter 18 "Fiscal Policy," Section B.
  • Blanchard, Olivier, Macroeconomics, 4th ed., Pearson Education, 2006, Chapter 26: "Fiscal Policy: A Summing Up."

II. The Nature and Institutions of the Monetary System

Session 6 (September 16): Basic Characteristics of Money

Key Questions
  • The Mengerian theory of money discussed by White predicts that individual economies will automatically converge toward a "common medium of exchange."
    • Why is a common medium useful?
    • Discuss the importance of the following characteristics of a potential medium: durability, divisibility, portability (in appropriate quantities for exchange), easily identified. To what extent did the cigarettes used as money in the POW camp fulfil these basic characteristics?
    • Is the medium of exchange a "natural monopoly" situation in which the only feasible equilibrium involves everyone using the same medium or is it possible for two alternative media to coexist?
    • Is involvement of a governmental entity (such as a central bank) necessary for an effective monetary system?
  • Goodhart develops a fine distinction between "medium of exchange" and "means of payment." What are some assets that are media of exchange but not means of payment? Should they be considered to be "money"?
  • Among the textbook roles that monetary assets play in an economy are medium of exchange or means of payment, unit of account, store of value, and standard of deferred payment. Is bitcoin money?
Readings
  • White, Lawrence H., The Theory of Monetary Institutions (Malden, Mass.: Blackwell, 1999), Chapter 1. [Print reserves]
  • Goodhart, Charles A. E., Money, Information and Uncertainty, 2nd edition, (Cambridge, Mass.: MIT Press, 1989), Chapter II. [E-reserves through Moodle]
  • Radford, R. A., "The Economic Organization of a P.O.W. Camp," Economica 12(48), November 1945, 189-201.
  • Recommended (but long) historical reading on U.S. monetary history: Davies, Glyn, A History of Money from Ancient Times to the Modern Day (Cardiff: University of Wales Press, 1994), Chapter 9.
  • Additional optional resource: Hammond, Bray, Banks and Politics in America from the Revolution to the Civil War, Princeton, N.J.: Princeton University Press, 1957.
  • Additional optional resource: Friedman, Milton, and Anna Schwartz, A Monetary History of the United States, 1867-1960, Princeton, N.J.: Princeton University Press, 1963. (These are both classics in U.S. monetary history. We shall read an important chapter from Friedman and Schwartz for our discussion of the Great Depression.)

Session 7 (September 18): Commodity Money and the Gold Standard

Key Questions
  • What are the "stock" demand and supply of gold and how do they differ from the "flow" demand and supply?
  • How is the ppg (purchasing power of gold) variable related to the aggregate price level of goods and services in a gold-standard economy?
  • Why is the ppg determined by stock demand and supply in the short run?
  • Why is the ppg determined by flow demand and (especially) supply in the long run?
  • What are the advantages and disadvantages of a gold standard? Would you recommend that the United States adopt a gold standard (or some other kind of commodity monetary standard)?
Readings
  • White, Theory of Monetary Institutions, Chapter 2. [Print reserves]

Session 8 (September 20): What Banks Do

Key Questions
  • Briefly discuss how banks perform each of the following roles:
    • Mitigating information problems
    • Transforming asset liquidity
    • Reducing risk through asset pooling
  • What are bank reserves? Why do banks hold them (in the pre-2008 world where they do not pay interest)?
  • What are the federal-funds interest rate and the Federal Reserve discount rate? How are they related to banks' need for reserves?
  • What is bank capital? Why do banks hold it?
Readings
  • Croushore, Dean, Money and Banking: A Policy Oriented Approach, Boston: Houghton-Mifflin, 2007, Chapter 8: How Banks Work. [E-reserves through Moodle.] [Note: This book was written before the 2008 financial crisis and the changes in banking that resulted from it.]
  • Craig, Ben R., and Sara Millington, "The Federal Funds Market since the Financial Crisis," Federal Reserve Bank of Cleveland Economic Commentary 2017-07. [A discussion of how this key market has changed in the aftermath of the crisis.]

Session 9 (September 23): Banks and Central Banks

Key Questions
  • Why are privately issued bank notes (currency) essentially similar to checks drawn on a private bank and endorsed by the payee? Would you have a preference for one over the other in payment? Why?
  • In a private "free banking" system without a government central bank, how does the "adverse clearing" effect prevent an individual bank from issuing excess amounts (in relation to its reserves) of its private bank notes?
  • What are the roles of a private "clearing-house association" in a free-banking system? How do they compare to the roles of a government central bank in modern economies?
Readings
  • White, Theory of Monetary Institutions, Chapters 3 through 5. [Print reserves]

Session 10 (September 25): Basic Principles of Bank Regulation

Key Questions
  • Evaluate the following statement: "All modern banks are illiquid, but only troubled banks are insolvent."
  • The Diamond-Dybvig model is commonly used as a simple representation of the depository banking system. Explain briefly why the desire of some depositors for early liquidity causes a bank run that can lead to insolvency. How can deposit insurance eliminate bank runs? How can a credible lender of last resort eliminate bank runs?
  • For each letter in the CAMELS assessment, explain briefly the term that it abbreviates and why it is a useful measure of bank health.
Readings
  • White, Theory of Monetary Institutions, Chapter 6. [Print reserves]
  • Spong, Kenneth, Banking Regulation: Its Purposes, Implementation, and Effects, 5th edition, Federal Reserve Bank of Kansas City, 2000. (An excellent, but quite long, overview of how and why financial institutions are regulated in the United States. This document should be skimmed to get an idea of the goals of Fed regulation before the 2008 financial crisis.)

III. Banking and Financial Crises

Session 11 (September 27): Theories of Financial Crises

Key Questions
  • What is a financial "bubble"? Can they ever form if investors are rational?
  • Why do investors often believe that "this time is different"?
  • Why does sovereign debt pose special default problems for lenders? 
  • If you were lending to the government of a country, would you rather lend in dollars or in the country's own currency? Why?
Readings
  • Kindleberger, Charles, and Robert Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises, 5th edition, Hoboken, N.J.: John Wiley & Sons, 2005, Chapters 1 and 2. [E-reserves through Moodle]
  • Reinhart, Carmen M., and Kenneth S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton, N.J.: Princeton University Press, 2009, Chapters 1, 2, 4, 6, and 10. [E-book available through Library Web site] (These are mostly short chapters, some of which have extensive tables that you can skim quickly.)
  • Reinhart, Carmen M., and Kenneth S. Rogoff, Recovery from Financial Crises: Evidence from 100 Episodes. American Economic Review 104(5), May 2014, 50-55.

Session 12 (September 30): Crises before the Great Depression 

Key Questions
  • From a brief examination of the "crisis chronicles," what common themes are found in the century of financial crises discussed there? 
  • There are diverse causes of these crises, not all of them purely financial. Which would you characterize as crises triggered by "real" events, which by bubbles, and which by instability arising from the banking sector?
  • How was the response of J. P. Morgan and his colleagues essential in resolving the Panic of 1907? Why was it important to distinguish between insolvent institutions (such as Knickerbocker Trust) and solvent ones (as they determined Trust Company of America to be)?
  • How does this response, and the crucial distinction between illiquidity and insolvency, feature in the design of the Federal Reserve System? 
Readings

Session 13 (October 2):  The Great Depression

Key Questions
  • Without going into details, what happened to money stocks, real income, and the price level in the United States between 1929 and 1932? How did the magnitude of these changes compare to earlier downturns?
  • Friedman and Schwartz identify six key events during the Great Contraction. In a sentence or two, explain what happened in each event and why it was important.
  • The "money multiplier" is the ratio of the money supply to the monetary base (which Friedman and Schwartz call "high-powered money") and depends positively on the deposit-reserve ratio and the deposit-currency ratio. (Note that modern analysis usually expresses these ratios as their reciprocals, the reserve-deposit and currency-deposit ratios.) Chart 31 of Friedman and Schwartz shows that both of these ratios fell dramatically during the contraction. Why did they decline? What effect did this decline have on the money supply and on the economy?
  • Some authors have blamed the Fed's adherence to the gold standard for making the Great Depression worse. Would Friedman and Schwartz agree? How does the evidence presented by Richardson and Troost contribute to that argument?
Readings
  • Friedman, Milton, and Anna Schwartz, A Monetary History of the United States, 1867-1960, Princeton, N.J.: Princeton University Press, 1963, Chapter 7: The Great Contraction, 1929-33. [E-reserves through Moodle] (This chapter is 121 pages long and has been published separately as a book called The Great Contraction. Although there is a lot of detail that is relatively unimportant, there are no sections that can be omitted completely. Extract as much as you can of F&S's interpretation of the events and the Fed's policy response during each of the sub-periods they analyze. Skim past the gory minutia about month-to-month changes in monetary stocks.)
  • Richardson, Gary, and William Troost, "Monetary Intervention Mitigated Banking Panics during the Great Depression: Quasi-Experimental Evidence from a Federal Reserve District Border" Journal of Political Economy 117(6), December 2009, 1031-73.

Session 14 (October 4): U.S. Financial Crises of the 1980s and 1990s

Key Questions
  • Many economists have argued in favor of regularly adjusting the value of banks' assets to market value ("marking to market"). If regulators had aggressively marked assets to market during the Third-World debt crisis, what would have happened? Would this have been desirable?
  • How is it that deposit-insured banks with low or negative capital can continue to operate unless a regulator intervenes? 
  • The policy of "regulatory forbearance" seemed to work well in the Third-World debt crisis and to be disastrous in the savings-and-loan crisis. Why? What was different about the two situations that caused different outcomes?
  • What do these two crises tell us about the doctrine of "too big to fail"?
Readings

Session 15 (October 7): The Origins of the 2008 Financial Crisis

Key Questions
  • What are "subprime" mortgages? What useful role can they play in the financial system?
  • Discuss the incentives of Washington Mutual in "encouraging" subprime lending. Was this lending economically beneficial?
  • Briefly explain what a "collateralized debt obligation" is and why it can perform a useful role in the allocation of financial resources. 
  • Briefly explain what a "credit default swap" is and why it can perform a useful role in the allocation of financial resources.
  • How did the prevalence of the above assets reduce the transparency of credit-worthiness in September 2008? Why did this make if impossible for regulators or bankers to perform the kind of overnight solvency assessment that Ben Strong's team did for J. P. Morgan in the early hours of the 1907 crisis? 
Readings

Session 16 (October 9): The Economic Impact of the 2008 Financial Crisis

Key Questions
  • It may seem obvious, but why do financial disturbances often cause recessions or depressions in the real economy?
  • Briefly define each of these terms as used by Gertler and Gilchrist:
    • External-finance premium
    • Leverage
    • Financial crises as "nonlinear events"
    • Shadow banks
  • The subprime lending crisis was largely a U.S. phenomenon, but the economic disturbance that resulted affected much of the world. Why?
  • What does the evidence say about the severity and persistence of recessions caused by financial crises? Why do economists think that this is true?
Readings

Session 17  (October 11): Bank Regulation and Financial Crises

Key Questions
  • Explain why extremely low (or negative) levels of bank capital lead to incentives to make risky investments and to incur long-term debts to finance short-term payouts to owners and managers.
  • Why might some banks be "too big to fail"? What implications does this have for bank regulation?
  • What are the basic provisions of the Dodd-Frank Act and how did they change bank regulation?
  • What is meant by "macroprudential regulation" and why might it be a good idea?
Readings

Session 18 (October 14): Regulation in Response to the 2008 Crisis

Key Questions
  • Briefly describe the rationale for each of the following post-crisis policy responses:
    • "Tiering"
    • Changing capital and leverage requirements
    • Stress testing
    • "Liquidity-coverage ratios"
  • Why might shadow banking present a regulatory problem? To what extent did regulatory changes after 2008 deal with the problem?
  • What are the goals of macroprudential regulation with respect to preventing crises? What are the tools?
  • To what extent have macroprudential policies been implemented effectively after 2008? What problems remain?
Readings

Session 19 (October 16): Mid-term exam 

IV. Money in the Macroeconomy

Sessions 20 and 21 (October 18 and 28): Theories of Money Demand 

Key Questions (do all questions for October 18)
  • In analyzing the demand for money, we usually simplify the model into one with two assets: money and "bonds," which represent all of the alternative assets. What are the two key differences that we assume between assets that we categorize as "money" and those we consider "bonds"?
  • What is the advantage that agents gain from holding more of their wealth in the form of money? What is the disadvantage?
  • We are accustomed to thinking that everything in demand functions should be "real." Explain the difference between nominal and real for both the quantity of money demanded and the interest rate, and why the real demand for money depends on the nominal interest rate.
  • The Baumol-Tobin model assumes that the representative individual gets paid in a "lumpy" manner, getting a relatively large paycheck relatively infrequently (say, once a month), and spends in a "smooth" manner, at a constant rate over time. It's hard to do this in words, but describe the daily pattern of money holding for such an agent from one paycheck to the next, assuming that all of one paycheck's income is spent during the period before the next one. 
  • How would this pattern be different for someone who collects income smoothly (perhaps a taxi driver who gets paid in cash by every rider) but spends all of his or her income at the end of the month on rent and making a single credit-card payment to cover all over expenses? Would the resulting demand for money be any different? What about for someone for whom both income and expenditures are smooth or for whom both happen entirely at the end of the month?
Readings
  • Parker, Jeffrey. Economics 314 Coursebook, 2019 edition, Chapter 7 "Money, Inflation, Growth, and Cycles," Section F (omit final subsection on New Keynesian LM curve).
  • McCallum, Bennett T., Monetary Economics: Theory and Policy, New York: Macmillan, 1989, Chapter 3. [E-reserves throgh Moodle]
  • For more details on money demand: 
    • Laidler, David E.W., The Demand for Money: Theories, Evidence, and Problems, 3rd edition, New York, Harper & Row, 1985.
    • Goodhart, Charles A.E., Money, Information, and Uncertainty, 2nd edition, Cambridge, Mass.: MIT Press, 1989, Chapters III and IV. 

 

Session 22 (October 30): Credit and Bank Lending Channels of Monetary Policy

Key Questions
  • Friedman and Schwartz place great emphasis on the behavior of the money supply in worsening the Great Depression. Bernanke instead stresses the role of credit availability. What makes this argument different? Are the two arguments mutually exclusive or could both be important?
  • Bernanke and Gertler assert (correctly) that empirical research has struggled to find a significant effect of interest rates (the cost of capital) on real investment spending. Explain why this is a problem for the traditional IS/LM explanation of why monetary policy affects aggregate demand.
  • How do Bernanke and Gertler think that the "credit channel" explains this anomaly for the pre-2008 period?
  • What do Giambacorta and Marques-Ibanez learn about the credit and bank channels through analysis of the recent financial crisis? What policy recommendations do they draw?
Readings

Session 23 (November 1): Empirical Evidence on Traditional Monetary Policy 

Key Questions
  • What is a "monetary-policy shock" and why is it crucial to identify them in order to estimate the effect of monetary policy?
  • How does the vector-autoregression approach identify these shocks? What assumptions must be made for this to be valid?
  • How does Romer and Romer's "narrative approach" identify such shocks? What are the advantages and disadvantages of this approach?
Readings

Session 24 (November 4): Unconventional Monetary Policy and Quantitative Easing

Key Questions
  • How does "unconventional" monetary policy differ from "conventional" monetary policy? Why was it necessary?
  • Briefly describe the "portfolio-substitution channel" and the "bank-funding channel" discussed by Joyce et al. 
  • What is "forward guidance"? Give an example of how it might work.
  • Very briefly, what evidence do Eberly, Stock, and Wright find for the U.S. recovery and the effects of unconventional policy?
Readings

Session 25 (November 6): Empirical Estimates of the Effects of Quantitative Easing

Key Questions
  • Briefly summarize the evidence cited by Kuttner about unconventional policy in the United States.
  • Briefly summarize the evidence cited by Dell'Ariccia, Rabanal, and Sandri about unconventional policy in the Eura Area, Japan, and the U.K.
Readings

V. Monetary Policy and Inflation

Session 26 (November 8): Seigniorage

Key Questions
  • Explain the meaning of White's formula on page 139 for the sovereign's seigniorage in a specie-coin system and use it to answer the following question: If gold costs $20/ounce, why must a $20 coin contain less than one ounce of gold? Why are people willing to hold such a coin?
  • Briefly explain why the "Bailey curve" or the "inflation Laffer curve" has the shape that it does.
  • Seigniorage is closely related to the concept of an "inflation tax." Who receives revenue from the inflation tax and how? Who pays the inflation tax and how?
  • Click presents several tables of regressions (focus on Tables 2 and 5) testing various models of how much seigniorage governments choose to collect. For each of the following variables, explain how it is expected to affect the optimal amount of seigniorage and what his empirical evidence says:
    • Elasticity (or semi-elasticity) of money demand
    • Per-capita GDP
    • Government spending as share of GDP
    • Variation (standard deviation) of government spending
    • Creditworthiness of government
    • Domestic government debt as share of GDP
Readings
  • White, The Theory of Monetary Institutions, Chapter 7 (appendices optional). [Print reserves]
  • Recommended, but not required: Buiter, Willem H., "Seigniorage," Economics: The Open-Access, Open-Assessment E-journal, 1(2007-10), July 2007. (This is a bit laborious and mathematical, but covers important points that we will discuss in class.)
  • Click, Reid W., "Seigniorage in a Cross-Section of Countries," Journal of Money, Credit and Banking 30(2), May 1998, 154-71.

Session 27 (November 11): Inflation and Disinflation

Key Questions
  • Most of the hyperinflationary episodes in the bottom half of Table 2 followed the end of Communism. Under the Communist system money was abundant, but prices were artificially suppressed and goods and services were rationed by queues and scarcity. Why would the end of such a system lead to high inflation? Would you expect this inflation to be "ongoing" or more of a "one-time adjustment" of prices? Explain.
  • Milton Friedman is often quoted as saying "inflation is always and everywhere a monetary phenomenon." Does the evidence of Fischer, Sahay, and Vegh's Figure 2 and Table 6 support or refute this statement? Explain.
  • What is "exchange-rate-based stabilization"? Why might it be useful? What does the evidence in Fischer, Sahay, and Vegh's Table 13 and Figure 9 suggest?
  • The Phillips curve associates declining inflation with a rise in unemployment and recession in output. Explain the circumstances of the disinflations studied by Sargent and how the modern Phillips curve can explain them. How does this evidence relate to Fischer, Sahay, and Vegh's evidence in Figures 6 and 7?
  • Intuitively, how does Ball's "sacrifice ratio" measure the costs of disinflation? What factors seem (in his sample) to lead to lower costs?
Readings
  • Optional reading: Cagan, Philip, "The Monetary Dynamics of Hyperinflation," in Studies in the Quantity Theory of Money, ed. by Milton Friedman, Chicago: University of Chicago Press, 1956, 25-117. (This is the classic paper on hyperinflation, but it is quite long and emphasizes a number of issues that don't concern us.)
  • Fischer, Stanley, Ratna Sahay, and Carlos A. Vegh, "Modern Hyper- and High Inflations," Journal of Economic Literature 40(3), September 2002, 837-880.
  • Sargent, Thomas J., "The Ends of Four Big Inflations," in Inflation: Causes and Effects, ed. by R. E. Hall, Chicago: University of Chicago Press and NBER, 1982, 41-97. [E-reserves through Moodle]
  • Ball, Laurence, "What Determines the Sacrifice Ratio?" in Monetary Policy, ed. by N. G. Mankiw, Chicago: University of Chicago Press and NBER, 1994, 155-182. [E-reserves through Moodle]

Session 28 (November 13): Dynamic Inconsistency in Monetary Policy

Key Questions
  • What assumptions does this model make about policymakers' preferences about inflation and unemployment? Do these assumptions seem reasonable?
  • Why does the policymaker's optimal short-run policy differ from her long-run policy?
  • What happens if U* = Un? Why?
  • Does this model favor making monetary policy by rules or by discretion? Is the gold standard a good monetary system according to this model? Why? What arguments can be made on the other side of this debate?
Readings

Session 29 (November 15): Central-Bank Independence

Key Questions
  • What do we mean by "independence" of a central bank?
  • Why do we think that countries with independent central banks might have lower inflation? What does the empirical evidence say?
  • Briefly explain in words the argument that Acemoglu et al. make about why other institutional conditions matter for the effect of central-bank independence on inflation.
Readings

Session 30 (November 18): Operating Targets and Rules for Monetary Policy

Key Questions
  • Poole's analysis based on the simple IS/LM model argues that the optimal monetary instrument depends on the nature of the shocks to the economy. The U.S. has usually followed one of two choices: choosing a growth rate for the monetary base or choosing to peg an interest rate. Which instrument choice is optimal (and why) if most shocks come from
    • Volatility in spending decisions?
    • Volatility in money demand?
    • Volatility in the money-supply multiplier (ratio of M to monetary base)?
  • Clarida, Galí, and Gertler examine and estimate a "Taylor rule" for U.S. monetary policy. Such a policy determines a target nominal interest rate as depending on the output gap (GDP minus potential GDP) and inflation.
    • Why would the target nominal interest rate depend positively on the output gap and inflation?
    • Why should the effect of the inflation rate on the target nominal interest rate be greater than one in order to stabilize inflation?
    • What evidence do they find about this effect before and after Paul Volcker's appointment as Fed chair in 1979?
  • As described by Hamilton, how does the Fed's current policy landscape differ from that described by Poole? What implications does he draw from this?
Readings

Session 31 (November 20): Inflation Targeting

Key Questions
  • What is the difference between "inflation targeting" and "price-level targeting"? How would you characterize a gold standard?
  • Is a Taylor rule consistent with inflation targeting? Explain.
  • What evidence do Levin, Natalucci, and Piper find for the effects of inflation targeting when applied by developed countries and to emerging economies?
  • What evidence do Gonçalves and Salles find for the effects of inflation targeting when applied by emerging economies?
Readings

VI. Fiscal Policy

Session 32 (November 22): Theories of Fiscal Policy

Key Questions
  • Review: Describe the effects of an increase in government spending or a decrease in taxes using the simple IS/LM and AD/AS model. Are the effects different in the short run and the long run? Explain.
  • If the zero lower bound on nominal interest rates makes the LM curve horizontal, will that make the effects larger or smaller? Why?
  • Describe the policymaking process by which government spending and taxes are set. Why does this lead to long "decision" lags for fiscal policy?
  • What is "crowding out" and why does it happen? What are its implications for the effectiveness of fiscal policy?
  • Suppose that you are a fully "Ricardian" consumer and realize that the government has lowered your taxes without changing its spending (now or in the future). Your disposable income has increased. How should you change your saving and consumption: Save the entire increase? Spend the entire increase? Or save part and spend part?
Readings
  • Blanchard, Olivier, Macroeconomics, 4th ed., Pearson Education, 2006, Chapter 26: "Fiscal Policy: A Summing Up." [Print reserves]
  • Blinder, Alan S., "The Case Against the Case Against Discretionary Fiscal Policy," in The Macroeconomics of Fiscal Policy, edited by R. W. Kopcke, G. H. B. Tootell, and R. K. Triest, MIT Press, 2006. [E-reserves through Moodle]
  • Bernheim, B. Douglas, "A Neoclassical Perspective on Budget Deficits," Journal of Economic Perspectives 3(2), Spring 1989, 55-72.
  • Barro, Robert J., "The Ricardian Approach to Budget Deficits," Journal of Economic Perspectives 3(2), Spring 1989, 37-54.

Session 33 (November 25): Empirical Effects of Fiscal Policy I

Key Questions
  • The Keynesian income-expenditure model implies a multiplier equal to 1/(1-MPC), where MPC is the marginal propensity to consume. Yet many/most of the multipliers cited in the literature are less than one. Is the MPC negative or is there an alternative explanation?
  • Ramey asserts that "The time series approach requires exogenous variation in policy. The leading approaches to identifying this exogenous variation are structural vector autoregressions and natural experiment methods,
    combined with narrative methods that use historical documents to create new data series of exogenous changes." Explain.
  • What do macroeconomists mean by "fiscal austerity"? Why is it put in place? Why is it controversial?
  • What does the empirical research suggest about the relative contractionary effects of reduced spending vs, raising taxes for indebted countries undertaking austerity. Which of the theoretical explanations offered by Alesina et al. do you think are the most important in explaining this result?
Required Reading
Optional Additional Readings

Session 34 (November 27): Empirical Effects of Fiscal Policy II

Key Questions
  • Describe the narrative methodology used by Romer and Romer in their two papers. How does it compare with the method they used in the paper on monetary policy we read earlier? Is it a convincing solution to the problem of identifying policy shocks?
  • Briefly describe the tax-rebate program introduced in 2008 as the economy responded to the financial crisis. How did Shapiro and Slemrod assess its effectiveness? How effective was it? 
  • Very briefly assess the implications for economic behavior of the following changes enacted by the 2017 tax-law change:
    • Lowering the corporate-income-tax rate
    • Lowering personal-income-tax rates
    • Changing deductibility provisions of the personal income tax
Readings

Session 35 (December 2): Government Debt and Deficits: Basic Analysis

Key Questions
  • Why do we measure government debt and deficits as shares of GDP?
  • What is the "primary government surplus/deficit" and why is it important?
  • Explain why the difference between the interest rate and the GDP growth rate is crucial for the dynamics of debt in a country with a balanced primary budget.
  • What factors determine whether or not the inflation tax is an option for a deeply indebted country?
Readings

Session 36 (December 4): Government Debt and Deficits: Details and Empirical Evidence

Key Questions
  • What are the arguments for and against large primary surpluses for indebted European countries? What would you recommend?
  • Economists have often claimed that U.S. government debt is not a problem because the Federal Reserve could simply "inflate it away." What are some of the reasons why this is more problematic than simple models would suggest?
  • What are the main fiscal-policy implications of Blanchard's AEA presidential address? What are the key observations or assumptions that lead to his conclusions?
Readings
Additional Optional Readings
  • Panizza, Ugo, and Andrea F. Presbitero. 2014. Public Debt and Economic Growth: Is There a Causal Effect? Journal of Macroeconomics 41:21-41. 
  • Plosser, Charles I., "Government Financing Decisions and Asset Returns," Journal of Monetary Economics 9, May 1982, 325-352.
  • Barro, Robert J., "Government Spending, Interest Rates, Prices, and Budget Deficits in the United Kingdom, 1701-1918," Journal of Monetary Economics 20, 1987, 221-247.

Session 37 (December 6): Electoral Politics and Economic Policy

Key Questions
  • The simple "political business cycle" model assumes that agents have myopic expectations about inflation (and about economic policy. Why is this important? What are the characteristics of the cycle that it predicts?
  • In the partisan model, how do agents formulate expectations of inflation? How, then, are the actual rates of inflation and unemployment detemined after the election? Which will affect unemployment more, a highly (and correctly) predicted outcome or a total surprise in which the candidate who actually won was given little chance? Why?
  • What is "rational retrospective voting"?
Readings
  • White, Theory of Monetary Institutions, Chapter 9. [Print reserves]
  • Alesina, Alberto, and Nouriel Roubini, Political Cycles and the Macroeconomy, (Cambridge, Mass.: MIT Press, 1997), Chapters 1 through 3. [E-reserves through Moodle]

Sessions 38 and 39 (December 9 and 11): Economic Policy Project Presentations

Final Exam: Monday, December 16, 9am-noon.