Long-Run Effects of Short-Run Stabilization Policy

Frontmatter

Long-run Effects of Short-run Stabilization Policy—An Introduction

Abstract

Against the background of the failures of stabilization policies in most developed countries during the 1970s, it seems natural that a more critical attitude towards such policies has gradually evolved. The skepticism has usually focused on the long-run effects of stabilization policy, which is the theme of this conference.

Lars Calmfors

The Current Account in the Macroeconomic Adjustment Process

Abstract

Macroeconomic adjustments to changes in the economic environment are to a large extent conditioned by the intertemporal choices of economic agents. When agents face an intertemporal budget constraint, a decision to alter current indebtedness implies changes in future consumption possibilities and will be based on expectations of the entire future path of key variables and not only current variables. A formal model to show how today’s current account is a function of both current and future economic variables is presented. The determination of the current account under classical assumptions of market clearing and continuous full employment is emphasized.

Jeffrey Sachs

Comment on J. D. Sachs, “The Current Account in the Macroeconomic Adjustment Process”

Abstract

I would like to take up two issues raised in Jeff Sachs’ paper which are of particular relevance for the theme of the conference. The first concerns the long-run effects of temporary government expenditure policies; the second relates to the question of government attitudes towards foreign borrowing and the concept of an optimum current account policy.

Hans Genberg

Global Effects of National Stabilization Policies under Fixed and Floating Exchange Rates

Abstract

This paper deals with international effects of two types of stabilization policies: monetary expansion directed towards the demand side and a reduction in payroll taxes directed towards the supply side. The analysis focuses on employment, relative prices and welfare issues. It rests on a simple intertemporal general equilibrium model of two countries that includes a specific micro theory of money. Under floating exchange rates, a country’s employment is insulated from both policies abroad, but its consumption generally changes. Under fixed exchange rates, no such insulation prevails; while monetary expansion is generally expansionary, reduced payroll taxes constitute a beggar-thy-neighbor policy. In both systems, the welfare of a country may decrease although its employment increases—an “immiserizing expansion” may occur.

Torsten Persson

Comment on T. Persson, “Global Effects of National Stabilization Policies under Fixed and Floating Exchange Rates”

Abstract

The main concern of Persson’s paper is the effects of stabilization policies on employment in a two-country framework and under alternative exchange rate systems. This familiar issue has been a major preoccupation in the open economy macroeconomics litterature for many years. The analysis in this paper, however, is carried out in a new framework. The framework is based on a general equilibrium approach with optimizing consumers. The advantages of such an approach are that it enables us (a) to isolate the effects of policies, expectations, payment arrangements, exchange rate systems, etc. in a consistent manner; and (b) to carry out welfare evaluations. These evaluations are based on the same objective functions from which individual behavior is derived. This approach provides a departure from the more commonly used—but rather vague—notion of economic stabilization.

Assaf Razin

Adjustment and Structural Change under Supply Shocks

Abstract

The resource boom effect and the input price effect of raw material price changes are analyzed within a two-period, two-sector (plus resource industry), open economy framework. Diagrammatic exposition is used to study the “Dutch disease”, and in particular the distinction between the short-term wealth effects (causing a real appreciation and a movement of variable factors from tradeable to nontradeable industries) and the long-run effects on total investment, its sectoral allocation and its finance by foreign borrowing. The framework further enables analysis of the different allocational effects of temporary versus permanent raw material price increases, when the two sectors differ in material use. The effects of changes in the world interest rate on factor allocation and foreign borrowing, and the allocational effects of government intervention in the case of temporary real wage rigidity are also discussed.

Michael Bruno

Comment on M. Bruno, “Adjustment and Structural Change under Supply Shocks”

Abstract

Bruno analyzes short-run and long-run allocational effects of temporary and permanent increases in the prices of imported raw materials, a decrease in the world rate of interest, and several other kinds of disturbances. More precisely, the effects on production and consumption of traded and nontraded final goods, investment and the trade balance are considered.

Lars E. O. Svensson

Sectoral Shocks in a Dependent Economy: Long-run Adjustment and Short-run Accommodation

Abstract

This paper examines the allocation and stabilization consequences of a resource boom in a small open economy. Both the intersectoral allocation of capital and the price of non-traded goods adjust sluggishly; in contrast the nominal exchange rate adjusts instantaneously to ensure that the conditions for uncovered interest parity in the presence of rational exchange rate expectations are always met. The ability of monetary policy to stabilize the economy is examined, and it is shown that, even when intervention is justified in principle, policy errors which arise from confusing real and monetary shocks may worsen macroeconomic performance.

J. Peter Neary, Douglas D. Purvis

Comment on J. P. Neary and D. D. Purvis, “Sectoral Shocks in a Dependent Economy: Long-run Adjustment and Short-run Accomodation”

Abstract

The results of this paper are plausible enough, but I have considerable reservations as to whether the model presented is well designed to illustrate the central proposition. Moreover there are a number of problems in the structure of the model and the details of its exposition. In this comment I take these points in turn.

John S. Flemming

Stabilization, Allocation and the 1970s Oil Price Shocks

Abstract

The stabilization and allocation effects of two types of policy adopted by Canada in the 1970s to shelter the domestic economy from the 1973–74 and 1979–80 oil shocks are analyzed in this paper. After outlining the model, estimates of the effects of alternative Canadian energy pricing strategies are presented. The stabilization and allocation effects of the relatively expansionary public spending policies in Canada during the world industrial recession after the first oil shock are compared.

John F. Helliwell, Paul M. Boothe, Robert N. McRae

Comment on J. F. Helliwell, P. M. Boothe and R. N. McRae, “Stabilization, Allocation and the 1970s Oil Price Shocks”

Abstract

It is well known that the small open economy can protect itself from external shocks in various ways. In the 1970s, we have witnessed the attempts of a number of small countries (e.g. Canada, Australia and the Scandinavian countries) to cushion the effects of the oil price shocks. These attempts have met with varying degrees of success (or failure) from a stabilization point of view. The inflationary effects of the oil price rise have been allowed to reach the domestic economy only gradually through exchange rate adjustments or price control schemes; domestic aggregate demand and employment have been maintained through expansionary fiscal and monetary policy. Such stabilization is obviously bought at a cost. The oil price rises are generally considered to have caused a substantial permanent change in the relative price of energy in the world. For a small country to ignore and try to avoid this signal from the world market will sooner or later lead to serious losses in allocational efficiency. Although this trade-off between stabilization and efficiency is a simple and generally accepted truth, there are, to my knowledge, very few attempts to quantify it.

Staffan Viotti

Inflation, Tax Rules and the Accumulation of Residential and Nonresidential Capital

Abstract

The present paper analyses the effect of the interaction between tax rules and inflation on the size and allocation of the capital stock with particular emphasis on the role of owner-occupied housing. The analysis is developed in the framework of an economy that is in equilibrium and in which a constant fraction of disposable income is saved. In this model, I show that, with current U.S. tax laws, an increase in the rate of inflation reduces the equilibrium amount of business capital employed in the economy and raises the amount of housing capital. The analysis also shows that a higher rate of inflation lowers the real net-of-tax rate of return to the provider of business capital. Another result is that accelerated depreciation increases the accumulation of business capital but that, unless firms are permitted to expense all investment immediately, an increase in inflation continues to depress the accumulation of business capital.

Martin Feldstein

Comment on M. Feldstein, “Inflation, Tax Rules and the Accumulation of Residential and Nonresidential Capital”

Abstract

It is a familiar point that investment in dwellings is encouraged, relative to other investment, by the nonimputation for tax purposes of the rental of owner-occupied dwellings. The possible source of bias in favour of residential investment indicated by Feldstein is entirely separate from this. It arises because inflation affects differently the tax liability on the return from the two different types of investment, on two accounts: the allowance made for inflation in measuring depreciation and inventory costs for corporate tax is incomplete; and the personal tax rate may not be the same as the corporate tax rate. In practice, Feldstein suggests, the first of these is the one that matters.

R. C. O. Matthews

Profitability and Growth

Abstract

The link between profitability and growth is explored by means of an alternative explanation suggested by standard neoclassical theory of the firm. The growth model developed clarifies the relationships between the real wage rate, the rate of profit, taxation and savings behavior and the rate of growth.

Pentti J. K. Kouri

Comment on P. J. K. Kouri, “Profitability and Growth”

Abstract

The purpose of Kouri’s paper is to establish an explicit link between profitability and growth in an economy characterized by capital shortage and excess supply of labor. This link is derived from the effect of the rate of profit on the investment behavior of intertemporally profit-maximizing firms which, in the second part of the paper, is taken to interact with the saving behavior of intertemporally utility-maximizing households.

Thorvaldur Gylfason

Employment Policies, Wage Formation and Trade Union Behavior in a Small Open Economy

Abstract

A model of trade-union determined wages is developed which provides an explanation of underemployment based on optimizing behavior. It is shown that fiscal policy will in general affect employment under perfect foresight and immediate wage flexibility. Future consequences of short-run stabilization policies are discussed. Ratchet effects with respect to government expenditure and game-theoretic interdependence between government and trade union behavior are emphasized. If the trade union takes short-run policy measures in order to increase employment as an indication of an employment stabilization rule, the future behavior of the trade union changes and the result may be a decrease in long-run employment.

Lars Calmfors

Comment on L. Calmfors, “Employment Policies, Wage Formation and Trade Union Behavior in a Small Open Economy”

Abstract

Calmfors describes an open economy with a strong trade union and highly centralized wage negotiations. These are features which on the whole fit both Sweden and Norway very well, although a few objections will be raised below. The paper is therefore a valuable contribution to our understanding of the functioning of economies such as Norway and Sweden, and probably several other European countries. Although Calmfors’ analysis is carried out within the context of a particular macroeconomic model, most of his conclusions are valid for a wide range of specifications of an open economy.

Michael Hoel

General Discussion: What Have We Learned?

Abstract

Assar Lindbeck: The purpose of this conference has been to analyze the consequences of short-term stabilization policy for the allocation of resources. The idea behind this final discussion is an attempt to summarize what we have learned. However, before we try to answer this question, it may be useful to try to answer a somewhat easier question: what have been the main themes of the conference?

Nils Gottfries, Torsten Persson