Chapter 16, Problem 1P

Sub-part

A

To determine

The role of the speed of adjustment of the nominal wage in the debate between the active and passive approaches

Explanation of Solution

Active monetary policy involves the strategic use of monetary policy to counteractmacroeconomic expansions and contractions. Passive monetary policy occurs when central banks purposefully choose to only stabilize money and price levels without changing the course of the economy. During the fluctuations in the economy, the policymakers adopting active policy will act immediately, while those adopting passive policy have a time lag while taking a corrective course of action.

The main difference between the active and passive policy is due to the time lags for the enacting the policy. Therefore, the debate between the two types of the policies will come down to the speed at which the economic variable self-corrects and how long will it take for the agents to adjust their expectations. Therefore, the role that each of the following plays in the debate between active and passive policy is as follows:

The speed of adjustment of the nominal wage-faster adjustment of nominal wages means less need for active policy and greater time is available with the policymakers to make a corrective action, therefore, making case for passive policy.

Economics Concept Introduction

Introduction:

Active Policy: It involves the decision of the central bank to deliberately act on the policy to change and alter the course of the economy through using fiscal and monetary measures

Passive Policy: It involves using policy to stabilize the economy and price levels using pre-defined by a set of rules, without changing the course of the economy

Nominal Wage: The wage-in hand that does not take into the change in the prices is known as the Nominal Wages

Inflation: The change in the overall prices of the economy, thereby reducing the overall purchasing power of the citizens is known as Inflation

Unemployment: An economic condition wherein the number of jobs available in the economy is less than the people actively looking for the jobs

Sub-Part

B

To determine

The role of the speed of adjustment of expectations about inflation in the debate between the active and passive approaches

Explanation of Solution

The speed of adjustment of expectations about the inflation-faster adjustment of inflation expectations means that the short-run aggregate supply curve will accommodate the expectations in a shorter time period and therefore, strengthens the position for passive policy.

Economics Concept Introduction

Introduction:

Active Policy: It involves the decision of the central bank to deliberately act on the policy to change and alter the course of the economy through using fiscal and monetary measures

Passive Policy: It involves using policy to stabilize the economy and price levels using pre-defined by a set of rules, without changing the course of the economy

Nominal Wage: The wage-in hand that does not take into the change in the prices is known as the Nominal Wages

Inflation: The change in the overall prices of the economy, thereby reducing the overall purchasing power of the citizens is known as Inflation

Unemployment: An economic condition wherein the number of jobs available in the economy is less than the people actively looking for the jobs

Sub-Part

C

To determine

The role of the existence of lags in policy creation and implementation in the debate between the active and passive approaches

Explanation of Solution

Longer lags in policy creation and implementation: If there are long time lags for the policy-making and implementation, then by the time active policy would have acted, the other factors in the economy would have gone for self-correctness and adjustment of expectations would be done by the agents. Therefore, longer lags make active policy ineffective.

Economics Concept Introduction

Introduction:

Active Policy: It involves the decision of the central bank to deliberately act on the policy to change and alter the course of the economy through using fiscal and monetary measures

Passive Policy: It involves using policy to stabilize the economy and price levels using pre-defined by a set of rules, without changing the course of the economy

Nominal Wage: The wage-in hand that does not take into the change in the prices is known as the Nominal Wages

Inflation: The change in the overall prices of the economy, thereby reducing the overall purchasing power of the citizens is known as Inflation

Unemployment: An economic condition wherein the number of jobs available in the economy is less than the people actively looking for the jobs

Sub-Part

D

To determine

The role of the variability in the natural rate of unemployment over time in the debate between the active and passive approaches

Explanation of Solution

Variability in the natural rate of unemployment over time: If there is more variability in the natural rate of unemployment over time makes active policy ineffective as the changes made will not hold for longer duration of time, thus making passive policy an attractive option.

Economics Concept Introduction

Introduction:

Active Policy: It involves the decision of the central bank to deliberately act on the policy to change and alter the course of the economy through using fiscal and monetary measures

Passive Policy: It involves using policy to stabilize the economy and price levels using pre-defined by a set of rules, without changing the course of the economy

Nominal Wage: The wage-in hand that does not take into the change in the prices is known as the Nominal Wages

Inflation: The change in the overall prices of the economy, thereby reducing the overall purchasing power of the citizens is known as Inflation

Unemployment: An economic condition wherein the number of jobs available in the economy is less than the people actively looking for the jobs