Question

1. From the perspective of Orthodox Monetarism, discuss the merits of rule-based vs. discretionary fiscal and monetary policy with regard to stabilizing the macroeconomy. Be sure to include the assumptions made by the Monetarists in your answer.
2. From the perspective of the New Classical School, discuss the merits of rule-based vs. discretionary fiscal and monetary policy with regard to stabilizing the macroeconomy. Be sure to include the assumptions made by the New Classical School in your answer.

Answer 1

Orthodox monetarism- Assumptions

1. The economy's performance is determined entirely by changes in money supply.
2. Monetarists postulate that the economic health of an economy can be best controlled by a governing body

Rules-based fiscal and monetary policy

Rules-based policy is less interventionist, more predictable, and more systematic.

In monetary policy, the Government adheres to a steady and predictable strategy for adjusting interest rates or the money supply.

In fiscal policy, the legislators and executives set long-term debt, spending, and revenue policies and rely on automatic stabilizers such as unemployment benefits and other transfer programs that are sensitive to changes in the business cycle to further counteract booms or busts.

Discretion-based fiscal and monetary policy

It is less predictable, more interventionist with a focus on short-term fine-tuning.

In monetary policy, the Government seeks to influence or respond to momentary fluctuations in unemployment and inflation without a long-term strategy.

Fiscal policy comes to involve targeted and temporary spending and tax changes, the goals of which are usually to produce a short-term stimulus.

New Classical School- Assumptions

1. It emphasizes the importance of microeconomics and models based on it.
2. They assume that all agents try to maximize their utility and have rational expectations.
3. They also assume that the market clears at all times.

Rules-based fiscal and monetary policy

A rule-based system for fiscal policy provides clear yardsticks against which other policy-makers and the public can measure the current and future course of policies. It sets up a stable and predictable environment, which allows markets to operate more efficiently, and supports longer-term decision-making by the public and by corporations.

Monetary policy, on the other hand, affects short-term interest rates, which influences the government budget and the economic environment in which governments operate

Discretion-based fiscal and monetary policy

There is a long time-lag between the preparation, the decision and the implementation of discretionary measures, in particular those aimed at stabilising the business cycle which gives enough time for improvements at any point.