Macroeconomic Policy: Demystifying Monetary and Fiscal Policy

298 Pages·2009·3.83 MB·English

by  Farrokh K. Langdana (auth.)

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,
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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
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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
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