Active apply discretionary policy to force the economy into a more favorable position thorough a com

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The Policy Debate Active or Passive?

• Active apply discretionary policy to force the
  economy into a more favorable position thorough a
  combination of monetary and fiscal policy
• Passive- letting natural forces bring the economy
  into equilibrium.

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Exhibit 1a Closing a Contractionary Gap(The
Passive Approach)
Economy at Equilibrium At Point A Higher
unemployment Will cause wages and Prices to
fall Supply then increases, Causing the economy
to Move to point b
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Exhibit 1b Closing a Contractionary Gap(The
Active Approach)
Activist approach Suggests that an Increase in
government Spending will increase Aggregate
demand Moving the AD to AD And the economy
into Equilibrium at point c
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Arguments

• Passive Approach works but it might take time
  for wages and prices to be negotiated downward-
• The longer it takes, the more output foregone in
  the interim
• Active Approach works- but it inherently reflects
  a higher-cost equilibrium point in the economy,
  with its obvious effect on the level of prices

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Exhibit 2a Policy Responses to an Expansionary
Gap(The Passive Approach)
Producing at a point higher than the LRAS
will Cause wages and prices To increase,
eventually Reducing short run Supply (SRAS) to
point e. Effect of higher prices, And a
slower adjustment.
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Exhibit 2b Policy Responses to an Expansionary
Gap(The Active Approach)
Activist policy reduces Government
expenditures, Reducing AD to AD, Lowering
prices and Reducing the economy Back to its long
run Potential output at point c. Note lower
Prices.
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Active Policy Problems

• Assumes a Natural Level of unemployment that is
  too low, and continue to push the economy to
  higher and higher levels in an attempt to reduce
  unemployment but resulting in just increased
  prices

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Lag Problems

• Recognition Lag- time it takes to identify a
  macro problem and to assess its seriousness
• Decision-making Lag- the time needed to decide
  what to do when a problem has been identified
• Implementation Lag- the time needed to introduce
  fiscal or monetary policy change
• Effectiveness Lag- the time for changes to have
  an effect in the economy

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Expectations have a significant effect on Policy
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Exhibit 3 Short-Run Effects of an Unexpected
Expansionary Monetary Policy
Economy at equilibrium At point a Activist
policy unexpectedly Stimulates demand, AD moves
to AD Higher costs more economy To Point c
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Exhibit 4 Short-Run Effects of the Fed Pursuing
a More Expansionary Policy than Announced
Fed announces monetary Policy to keep economy At
point c. If producers think prices Will be
higher, reduce supply Curve, more to point
d. Activist policy will force AD From AD,
OR passively, economy Will stay at point d
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Re-Read

• Example on Page 353 about Mall Manager and the
  level of heating in a building

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Exhibit 7 Short-Run Phillips Curves Since 1960