The choice between active and passive macroeconomic policy models is not the same as the choice between “firm-course policies” and “freedom of action”. A coherent macroeconomic policy (“firm-course policy” or “playing by the rules”) implies an early choice of measures that can be taken in a particular situation and which predetermine the practical steps of the government and the Central (National) Bank. A “firm course” means that the measures of the government and the Central Bank to change public spending, taxes and the money supply are limited by the quantitative framework of selected targets, which cannot be changed in accordance with the current economic situation. Therefore, the freedom of action of the government and the Central Bank is limited by the need to comply with pre-announced “rules of the game”.
An example of passive macroeconomic policy within the framework of a firm policy to stabilize the growth rate of the money supply is an increase in the money supply by 3% per year, regardless of the dynamics of the unemployment rate and other factors.
An example of an active policy within the framework of the above-mentioned rate of the Central Bank can be the following equality:
,
where 
is the growth rate of the money supply;
– the actual unemployment rate in the current and last year (respectively).
In both cases, the fixed rate of the Central Bank is, in terms of the IS-LM model, a shift in the LM curve to the right, as the Central Bank seeks to stabilize the declining economy by expanding the money supply. But the magnitude of this shift of the LM curve to the right is always the same with passive politics, and with active policy, an increase in dependence on the depth of the recession.
Inconsistent macroeconomic policies (policies of “freedom of action” or “freedom of initiative”) mean that the government and the central bank assess economic problems on a case-by-case basis, as they arise, and at any given moment discretionarily select the appropriate type of policy. Therefore, such a policy is also called discretionary, although in this case the content of this term is much broader than in the context of discretionary fiscal policy. “Freedom of action” means the absence of any quantitative framework that limits the ability of the government and the Central Bank to change government spending, taxes and the money supply.
The experience of macroeconomic regulation in industrialized countries shows that the “game by the rules” has undeniable advantages over arbitrary policies. These advantages, in their most general form, can be reduced to three circumstances.
1) Consistent macroeconomic policies reduce the risk of incompetent decisions. Incompetence in economic policy can be associated not so much with the incompetence of specific officials, but, firstly, an incompetent decision of the government can arise spontaneously, as a result of a clash of conflicting interests of various social groups; Second, imperfect information is a “breeding ground” for the actions of amateurs who offer tempting but unrealistic programs for quickly resolving complex macroeconomic problems. With firm policies of the government and the Central Bank, the risks of making incompetent decisions under the pressure of certain social groups or “popular” programs are reduced.
2) A firm-course policy reduces the impact of the political business cycle on the dynamics of employment levels, output and inflation. Politicians implementing fiscal and monetary policy measures are trying to ensure that by the time of the elections there are socially favorable conditions that would ensure the re-election of the leaders of this party for the next term. To this end, it is possible to first stimulate an increase in employment, and then reduce inflation as a result of tighter spending policies, which will provide relatively high employment with relatively moderate inflation by the time of re-election. The same result can be achieved with the help of the opposite combination of measures – first to conduct a tough anti-inflationary policy, accompanied by an increase in unemployment, and then a stimulating policy to increase employment and incomes. Thus, maneuvering the levels of employment and inflation is aimed not so much at ensuring sustainable economic growth as at ensuring political victory in the next elections. As a result, the political process itself becomes one of the factors of cyclical fluctuations in the economy.
Firm policies of the government and the Central Bank make it possible to relatively protect the economy from the influence of changes in the political situation. Adherence to a firm course reduces the possibility of fiscal and monetary maneuvers in the short term, but contributes to the stabilization of the economy in the long term.
3) “Playing by the rules” contributes to strengthening the confidence of economic agents in the policy of the government and the Central Bank. The problem of mistrust is not so much related to distrust of individual officials as to the possible refusal of the government and the Central Bank to make their promises to carry out certain economic measures. For example, under arbitrary macroeconomic policies, the government may announce preferential taxation of investment profits to attract capital to certain industries and regions. But when capital is already invested, the government can renege on its promises to reduce taxation, as this poses a threat of an increase in the state budget deficit. Another example: in order to stimulate innovation, the government issues patents to the inventors of new types of products, granting them a monopoly right to use it for a number of years and receive monopoly profits. But once inventions have already been made, the government can revoke the patents to make the products more accessible to the consumer.
In each of these cases, economic agents know that the government can break its promises. Therefore, they are insured against “deception” – they do not invest and do not make inventions. As a result of this inconsistent government policy, the economy as a whole loses significantly, as the stimulus for economic growth is blocked by pessimistic expectations.
A fixed-course policy that is not accompanied by any promises inspires more confidence among economic agents, makes expectations more rational and creates a generally more favorable environment in terms of long-term goals of economic growth.
Contradictory objectives of macroeconomic regulation and the problem of coordination of fiscal and monetary policy courses
Possible “firm courses” of government fiscal policy could include:
(a) The State budget, which is balanced annually;
b) the state budget, balanced in a longer period on a cyclical and functional basis.
The government’s policy on the annually balanced state budget:
– reduces the degree of “built-in” stability of the economy;
– causes frequent fluctuations in tax rates, which reduce investment activity;
– relatively reduces the incomes of today’s generation in favor of the future.
Since the exchange rate of an annually balanced budget is associated with significant costs, the budgets of most countries are balanced in the longer term. At the same time, the targets of fiscal policy, limiting the freedom of action of the government and directing it to maintain certain quantitative ratios, can be:
– Reduction of the total amount of public debt;
– stabilization of the debt/GDP ratio;
–
equalizing the growth rate of government spending and GDP growth;
– Equality or excess of net investment over net public debt.
These targets restrain the “appetites” of the departments spending the state budget, which are forced to correlate their requirements for new budget resources with these restrictions. Without such constraints, the dynamics of the actual government budget deficit can be difficult to manage.
Possible “fixed rates” of the monetary policy of the Central Bank include:
a) maintaining a stable rate of change in the money supply;
b) stabilization of the market interest rate;
c) stabilization of nominal GNP.
When the rate of change in the money supply stabilizes, the Central Bank sets a certain level of its growth for each year and, with the help of open market operations, discount policy or changes in the reserve ratio, maintains a stable money supply. With this policy, the LM curve has a positive slope: since the money supply is stable, a higher level of Y2 issue corresponds to a higher interest rate R2 (see Figure 11.1). This rate of the Central (National) Bank is effective at a relatively stable velocity of money circulation.
When the interest rate stabilizes, the Central Bank changes the money supply with the help of these instruments in such a way that the actual average market interest rate approaches the chosen target. This course makes it possible to relatively reduce the effect of crowding out private investment that accompanies stimulating fiscal policy. At the same time, the stabilization of the interest rate makes it possible to relatively stabilize the dynamics of the exchange rate, since, other things being equal, there is a positive functional dependence between these variables.
The stabilization of the interest rate can be graphically depicted as a horizontal curve LM, “fixed” at the level of the target benchmark R0 (see Figure 11.2).
If the government and the Central Bank successfully coordinate their actions, then the stabilization of the interest rate can be achieved with the traditional slopes of the IS and LM curves and their coordinated shifts (see Figure 11.3).
The anti-inflationary potential of the rate of change in the money supply is higher than the rate of stabilization of the market interest rate, but in the first case it is not possible to avoid the effect of displacement.
The policy of stabilizing nominal GNP has the greatest anti-inflationary potential, although the practical implementation of such a policy is complicated by the fact that GNP changes with a significant time lag to any measures. This course involves “fixing” the vertical curve LM at the level of the selected benchmark Y0 (see Figure 11.4).
If the actual nominal GNP is higher than the specified one, then the Central Bank, with the help of monetary policy measures, reduces the money supply, which is accompanied by a decrease in employment and output. If the actual GNP is below a given level, then the Central Bank conducts monetary expansion. Fluctuations in the level of employment under such policies can be significant, although in a longer period, the stabilization of output implies the stabilization of the unemployment rate.
The “straightening” of the LM curve generally involves coordinated action by the central bank and the government, as the LM curve becomes vertical at very high interest rates, which are accompanied by minimizing speculative demand for money and maintaining essentially only transactional demand for money. Such a significant increase in interest rates can be achieved with debt financing of the budget deficit, combined with the restrictive monetary policy of the Central Bank (see Figure 11.5).
The described course of state policy is most effective in situations where reducing inflation becomes the primary goal of macroeconomic regulation.
The experience of many countries shows that the policy of the Central Bank, which ensures a low stable growth rate of the money supply, is credible. However, such a policy is incompatible with the government’s fiscal policy, focused on a significant budget deficit. This incompatibility is explained by the limited possibilities of debt financing of the budget deficit and the inevitable increase in inflationary pressures even if the growth rate of the money supply stabilizes. In the context of the rapid growth of public debt, economic agents will not believe the promise of the Central Bank to adhere to a low growth rate of the money supply, and distrust will inevitably destabilize the overall macroeconomic situation. Therefore, the government’s systematic control over the dynamics of the budget deficit is a prerequisite for the successful implementation of the Central Bank’s anti-inflationary monetary policy.
In transition economies, the choice of the optimal combination of fiscal and monetary policy rates is hampered by a number of specific circumstances. First, there is often no necessary experience of macroeconomic regulation in general, and the experience of coordinating the actions of the government and the Central Bank in particular. Second, the objectively complex problem of building confidence in the economic policies of governments and the Central Bank is further complicated in situations of economic instability and distrust of individual officials. Third, the necessary social conditions are often lacking to ensure successful anti-inflationary containment at the cost of increasing unemployment. For example, the lack of a developed labor market infrastructure in Belarus, which would allow “displaced” workers to quickly get new professions and new jobs, makes it socially risky to pursue a tough anti-inflationary policy using the method of “shock therapy”.
The combination of these circumstances leads to the predominance of arbitrary macroeconomic policies of the government and the Central Bank, which do not contribute to confidence-building and prevent the rationalization of economic expectations. However, some economic policy measures, such as the establishment of a currency corridor, suggest that the government and the Central Bank are beginning to “inculcate” forms of rational behavior in economic agents. In favor of the conclusion about the possible movement towards the rationalization of expectations is evidenced by the abundance of macroeconomic information in the periodical press, as well as the appearance in the structure of private firms of special analytical units designed to give reasonable, “rational” forecasts of the future state of the economy, on the basis of which the non-state sector will make economic decisions.