Policy Making:
Exercises and Problems


1) What type of policy (fiscal, monetary or institutional) does each of the following measures represent?
- a) The freezing of all salaries of government employees with the intent to reduce the budget deficit the government.
- b) An increase in spending on highways;
- c) A cut in taxes for businesses;
- d) The introduction of a national health care insurance;
- e) The lowering of the discount rate by the Federal Reserve bank.

2) The government increases its spending by 10 percent.
- a) Use the classical model to argue the ineffectiveness of this policy (see Chapter 23).
- b) Use the basic Keynesian model, on the contrary, to demonstrate its effectiveness (see Chapters 24 and 25).
- c) Now make the case for the new classical economists.
- d) And for the new Keynesian economists.

3) Imagine an economy that experiences high inflation and low unemployment. The government is worried. What could it do to stem inflation? Two economic advisors come up with two different plans. One favors demand side policies, the other supply side policies.
- a) What might an anti-inflationary demand policy look like?
-b) What might an anti-inflationary supply policy look like? Identify instruments and appropriate intermediate targets. Show the alleged effects of each policy in a diagram with aggregate supply and demand.

4) Imagine that the monetary authorities are set on a monetarist policy of a constant money growth rule. What would that rule be if:
- a) M2 is considered the appropriate intermediate target?
- b) The economists of the Federal Reserve System have calculated that the velocity of M2 is declining at a rate of 1.5 percent annually?
- c) The desired economic growth is 2.5 percent and inflation should not exceed the 4 percent? [Hint: Use the quantity equation of money of Chapter 27.]


5) Debate two opinions, dividing the class in half to do so:
- a) The government should never run a deficit; what we need is a constitutional amendment that will force the government to balance its books.
- b) A government deficit is perfectly acceptable and should be allowed. 6) In 1992 the American President ordered employers to lower their withholding of taxes on the wages and salaries that they pay out. As a result the employees received more income each week. They were, however, expected to pay at the end of the year the same total amount of tax as before.
- a) What might have been the rationale for the policy? (Consider the economic situation as spelled out in the beginning of the chapter.)
- b) What would you say from a Keynesian perspective?
- c) And from a new classical or monetarist perspective?

7) Some economists argue that policy makers should be rule bound in the making of economic policy.
- a) Give a few examples of such rules.
- b) What are the arguments in support of these rules?

8) Keynesian economists advocate a monetary policy with interest rates as the intermediate target. What is the major monetarist/new classical criticism of such a policy?

9) How might Keynesians object to a rule of constant money growth?