Economics 1420 Memo #1 Comments

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Economics 1420 Memo #1 Comments

Eric Powell, March 2011

The following are general substantive and stylistic suggestions based on the first memo assignment. Some of your memos directly refer you to them (eg you will see “1” or “A” in the memo). Regardless, the suggestions are broadly applicable, and everyone would benefit from reviewing them.
A thorough policy memo is substantively complete and directed at the audience.

  1. You cannot prove a counterfactual. For example, although the stimulus packages have not observably reduced unemployment, it is possible (indeed, likely) that unemployment would have been higher without the packages.

  2. The Friedman model and lags should be part of your fiscal policy discussion.

  3. Regardless of your fiscal policy recommendation, you should discuss deficits.

    1. If you advise against additional stimulus, you were probably motivated by increasing deficits. However, you must address the following:

      1. Deficit spending may be a sensible policy when there are needs for massive expenditures, such as wars or prolonged recessions. The US has historically recovered from very high Debt/GDP ratios by subsequent fiscal prudence (tax smoothing).

      2. A sufficiently protracted recession may have severe long-term effects in addition to the short-term pain.

      3. Think creatively about fiscal policy: it might be possible to conduct expansionary fiscal policy while not substantially contributing to long-term debt. One example of this is moving future spending to the present, such as replacing worn out military tanks.

    2. If you recommend additional stimulus, you must address the effect fiscal spending will have on long-term economic health. There are a variety of potential reasons for concern:

      1. Public dissaving may reduce national saving, driving up long-term interest rates. This may reduce investment and, thus, lower future GDP.

      2. Increasing debt increases future interest costs. Paying these interest costs will eventually require tax increases or, alternatively, cuts in program spending.

      3. The potential exists for a hard landing if foreigners lose confidence that the US will ever pay off the debt.

  4. Monetary policy has been less effective in this recession because it does not address a major underlying cause of the spiraling economy—tight credit markets. Nonetheless, raising rates will almost definitely decrease AD: by reducing the money supply, the interest rate will rise and investment will fall. Thus, it is rare to simultaneously see contractionary monetary policy and expansionary fiscal policy.

  5. Ways to think about government spending:

    1. Different forms of government spending have different multipliers, eg low-income households have higher multipliers than high-income households

    2. Target productive forms of spending. The government could pay Person A to dig a hole and Person B to fill the hole. This will increase AD. Preferably, the government will pay for research or investment incentives that can increase LRAS.

    3. Increases in government spending or decreases in taxes can be temporary or permanent. Permanent increases are likely to shift AD further, but also lead to larger deficit increases.

    4. Increases in government spending can lead to unemployment decreases through multiple mechanisms. First, it leads to higher output, so people have more money to spend, stores must produce more in response, which requires more labor. Also, targeted tax programs, such as decreases in marginal labor tax rates, can decrease unemployment.

  6. You should talk about the Taylor Rule. Whether you call it that or write the equation is not of utmost importance. It is important to note that the Federal Reserve has a dual mandate: low, stable inflation (around 2%) and full employment (around 5.5% unemployment). This is a balancing act, since the Fed only has one variable to control two targets.

    1. Regardless of your monetary policy recommendation, you should talk about the risk of inflation. Most current measurements indicate that inflation remains low, largely because of excess capacity and business’s reluctance to charge consumers higher prices. As a general rule, though, low federal funds rates will over time lead to inflation.

      1. Some argued that we can keep the rates low in the face of high inflation until the economy recovers because “we know how to deal with high inflation.” Notice that we deal with high inflation by contractionary monetary policy, which contracts AD, causing a decrease in output and an increase in unemployment (remember the Volcker years); in short, we might cause a recession. Therefore, this reasoning requires some additional explanation.

  7. Reducing the federal funds rate increases investment. Savings increases, also (savings = investment). This may seem counterintuitive because there is less incentive to save. However, note than an increase in I increases Y, making more resources available. Some of those resources will be saved.

    1. More technically, if you think of the Keynesian Cross, lower interest rates cause an increase in planned investment. Firms use their inventories and increase production. This increases Y, some of which will be saved (S=Y-C-G).

The memo format is intended to convey information quickly. This has a number of stylistic implications.

  1. Use headings to direct the reader. You get even more bang-for-your-buck by making a heading a declarative sentence, eg instead of “Federal Funds Rate” you can say “The FOMC Should Maintain Its Low Federal Funds Rate.”

  2. If you use graphs, refer to them and explain them in the text.

  3. Grammar and spelling are important; shortcomings of either detracts from you’re credibltiy.

  4. Recognize likely counterarguments. Some you can rebut; this is good. Others you cannot; this is also important to give the policymaker a balanced view.

  5. Observe page limits. Do not try to squeeze more into the paper by having substantial footnotes, including graphs as an “appendix,” single-spacing bullets, decreasing margins, etc.

  6. Works cited, footnotes, and endnotes are not the preferable citation formats in memos. Ideally, you can work the source into the sentence, eg “CBO estimates the unemployment rate is . . .” If you must, use a parenthetical or footnote after something requiring citing, but keep it to just the source name and year, eg “(CBO, 2011).” Your audience is not going to search for sources himself. He wants to know where the facts come from. If he has a further desire to see the source, he will ask you for it (this means you should keep a fuller list of the sourcing).

  7. Prepare your reader for what you are about to tell him with one or two topic sentences. Do not, though, use up too much of your precious space with large summaries.

  8. Bullets can be effective means to convey information, but the entire four-page memo should not be in bullet format.

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