Questions and Answers on the Political Business Cycle and Banking - Paper Example

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University of California, Santa Barbara
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1. What Is Your View Of The Current Budget Deficit Situation?

In the United States, the current federal budget deficit is $440 billion for 2018 fiscal year. This occurred because the government is spending higher than the revenue they collect. The current budget deficit is within manageable range since the debt-to-GDP ratio is not past 100% which could have been a risk to the economy. The government had reduced the deficit for the budget of 2017 financial year, and there is a possibility that the deficit will become a surplus by 2027 financial year. I view the current deficit situation as good because it stimulates the economy through government spending and many countries will be willing to lend money to the country and jobs will be created.

2. What Causes The Lags In The Effect Of Monetary And Fiscal Policy On Aggregate Demand?

Most lags in monetary and fiscal policy arise from the spending plans which are set by firms and households in advance. This results in taking large time for the change of interest rates to affect the demand for goods and service. The fiscal policy lags are mostly caused by political processes where the policies have to be adjusted first like the cases of government spending and adjusted tax rates which have to pass through the government before it is enacted. Difficulties in predicting future economic conditions is another factor because the best policies will not be made. The lags will affect the economy in the long run.

3. What Are The Implications Of These Lags For The Debate Over Active Versus Passive Policy?

The implications arise because of the uncertainty of the economic science and the fact that policy can take very long time to get into the government system. The length of time might create unforeseen changes which render the policy unimportant since economies mostly work towards equilibrium. Economists argue that active policies will manage aggregate demand to compensate for instability. However, the active policy is likely to affect the economy with lags because of unexpected conditions in the economy and the fact that the future cannot be easily predicted therefore the passive policy should be implemented because of its efficiency in balancing the economy.

4. What Might Motivate A Central Banker To Cause A Political Business Cycle?

A central banker can cause a political business cycle because he/she wants to influence the results of an election in one way or the other. During elections, a person in power can collude with the manager of the central bank to present wrong projections about the economy of the country r county. By doing that, they convince the voters to vote back the incumbent because the economy is doing well. This kind of motivation is, however, harmful to the economy since the monetary policies are set by discretion rather by rules and will make the politicians raise the tax to control the situation after the election.

5. What Does The Political Business Cycle Imply For The Debate Over Policy Rules?

The political business cycle puts fiscal and monetary policies in an awkward position because it will be manipulated by the politicians who has powers over the treasury. Policy rules state that the policies should be altered by acts of law only thus the way politicians use them for political mileage is against the law. The policies should be systematic so as to avoid cases of boom and bust pattern which is likely to happen if they are interfered by incumbents in the government. Effects, in the long run, will include acceleration of inflation, low rates of savings and the possibility of the government to improve GDP at the expense of disposable income of people.

6. Explain How Credibility Might Affect The Cost Of Reducing Inflation.

The effects of credibility on the cost of reducing inflation will be observed though short-run Philips curve adjustments. If the government comes up with a convincing plan to reduce inflation, the curve will shift down so fast which will minimize the cost of disinflation. However, if the government offer unreal plan to curb the high inflation, there will be a further rise in inflation because it will shift the Philips curve upwards which makes disinflation more costly. The public trusts towards their authorities will affect how they are willing to adjust their expectations. The shift of the curve downwards will result to less costly tradeoffs between inflation and unemployment.

7. Explain Why Some Economists Are Against A Target Of Zero Inflation?

Zero inflation is viewed by some economists that the prices of commodities might remain at a certain point because inflation itself is about price changes thus commodities might become expensive. However, the zero inflation can be advantageous to the governments because it maintains lower inflation over the long run hence the interest rates, in the long run, will be more stable and lower. The incentive to pay is the main challenge in zero inflation because people will stop spending and the demand of products will decrease thus lowering prices. Low prices lead to deflation and also unemployment would rise tremendously. Therefore, zero inflation will not be important in the long run as compared to the short run and a little inflation is required.

8. What Adverse Effects Might Be Caused By Tax Incentives to Increase Saving?

Changes in taxes are susceptible in the long run because it has direct effects on the disposable income. To increase savings, taxes are increased the disposable income is likely to decline meaning people will have to cut consumption. Reduction in consumption will have negative effects on the real GDP because products will lack demand because it will not be bought by the consumers. The ultimate effect will be slow economic growth. Other effects will be on business where tax increase will make the small business to quit the market because of poor demand for products and low profit. This leads to loss of jobs thus cutting development of the country in future.


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