Chapter 24: Q. 12 (page 655)
Is stabilization policy more likely to be conducted through monetary policy or through fiscal policy? Why?
It is easier to handle problems with monetary policy.
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For aggregate demand shocks and permanent supply shocks, the price stability and economic activity stability objectives are consistent: Stabilizing inflation stabilizes economic activity, even in the short run. For temporary supply shocks, however, there is a trade-off between stabilizing inflation and stabilizing economic activity in the short run. In the long run, however, there is no conflict between stabilizing inflation and stabilizing economic activity.
Why does the self-correcting mechanism stop working when the policy rate hits the zero lower bound?
What will happen if policymakers erroneously believe that the natural rate of unemployment is 7% when it is actually 5% and therefore pursue stabilization policy?
“If the data and recognition lags could be reduced, activist policy probably would be more beneficial to the economy.” Is this statement true, false, or uncertain? Explain your answer.
In 2003, as the U.S. economy finally seemed poised to exit its ongoing recession, the Fed began to worry about a “soft patch” in the economy, in particular the possibility of a deflation. As a result, the Fed proactively lowered the federal funds rate from 1.75% in late 2002 to 1% by mid-2003, the lowest federal funds rate on record up to that point in time. In addition, the Fed committed to keeping the federal funds rate at this level for a considerable period of time. This policy was considered highly expansionary and was seen by some as potentially inflationary and unnecessary.
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