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today in the hope to get a lower price tomorrow) and investment (the real cost of borrowing and producing rises).  A real money expansion would help prices to rise again:

iii) When the recession is over, the government should resume normal policies of fiscal balance and price stability.  Fiscal balance will be helped by the increase in tax revenues due to the recovery; price control will be welcomed as a sign of financial and economic stability.  Eventually the normal path of growth and policy management would be restored.

Policies that the new classical school tells to avoid are recommended here. This just shows that macroeconomics is once more a question of judgement.  A policy is not good or bad overall but its effectiveness depends on a series of considerations: expectations of the financial markets, level of confidence in the economy, level of unemployment, level of inflation, fiscal budget, trade balance.  Not only might optimal policies vary between normal and extraordinary times (although it is hoped that situations like the Great Depression will not happen again) but also in normal times their effectiveness depends on operators' expectations (e.g., the different way in which Keynesian fiscal policies are perceived now, compared to twenty years ago, plays an important role in downgrading fiscal activism).  While the case for fiscal activism has been heavily qualified by the new economic consensus, fiscal policy can play a 'coarse-tuning' role when the objective is the avoidance of  major deviations from potential output.

Q2  The 1996 Annual Economic Report of the European Commission stated that (in reference to the French economy):

fiscal consolidation is a necessary condition for a stable macroeconomic environment conducive to growth and employment. It should enable an easing of monetary policy, compatible with monetary stability objective, which should offset the adverse effect on economic activity of budgetary restraint. (p. 24)

Explain each step of this argument by answering the following questions:

(a) What is a stable macroeconomic environment?

(b) What is meant by fiscal consolidation?

(c) Why is (b) necessary for (a)?

(d) Through what mechanism would (a) be conducive to growth and employment?

(e) Revise your understanding of the terms 'an easing of monetary policy' and 'monetary stability' (see chapter 13).

(f) What evidence would you wish to consult in order to be satisfied that monetary policy could be 'eased' without endangering 'the monetary stability objective'?

(a) A stable macroeconomic environment is attained when inflation is low (or prices are stable), public accounts are under control, interest rates are low and market-friendly policies are implemented.

(b) Fiscal consolidation means stability or decline in the debt : GDP ratio.  This depends on the current nominal interest rate (i), the nominal growth rate of the economy (g) and the ratio debt : GDP (k) (see appendix 15.1).  To maintain a constant debt : GDP ratio, since the government spends for interest repayments on current debt, a primary balance


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