Stabilization Policy

Should Policy Be Active or Passive?

Policymakers in the federal government view economic stabilization as one of their primary responsibilities. Monetary and fiscal policy can exert a powerful impact on aggregate demand and, thereby, on inflation and unemployment. When the president is considering a major change in fiscal policy, or when Bank Indonesia is considering a major change in monetary policy, foremost in the discussion are how the change will influence inflation and unemployment and whether aggregate demand needs to be stimulated or restrained.

Lags in the Implementation and Effects of Policies

Economic stabilization would be easy if the effects of policy were immediate. But, economic policymakers face the problem of long lags. Indeed, the problem for policymakers is even more difficult, because the lengths of the lags are hard to predict. These long and variable lags greatly complicate the conduct of monetary and fiscal policy. Some policies, called automatic stabilizers, are designed to reduce the lags associated with stabilization policy. Automatic stabilizers are policies that stimulate or depress the economy when necessary without any deliberate policy change.

Should Policy Be Conducted by Rule or by Discretion?

Policy is conducted by rule if policymakers announce in advance how policy will respond to various situations and commit themselves to following through on this announcement. Policy is conducted by discretion if policymakers are free to size up events as they occur and choose whatever policy they consider appropriate at the time.

Distrust of Policymakers and the Political Process

Opportunism in economic policy arises when the objectives of policymakers conflict with the well-being of the public. Some economists fear that politicians use macroeconomic policy to further their own electoral ends. Manipulation of the economy for electoral gain are called the political business cycle.