The Paradox of Macroeconomic Policy

Macroeconomic policy consists of fiscal policy and monetary policy --- two avenues available for governments to possibly bring economic stability and prosperity to their countries. Economists have long debated both the morality and the efficacy of such measures. Even when they do result in clear benefits, those benefits only come at the cost of some other aspect of the economy.

Fiat vs. Commodity

The currency that a country recognizes as its standard measurement of wealth, which buyers and sellers use to denominate all of their transactions, can exist as either fiat or commodity currency. Commodity currency is currency that has a value tied to the market value of some commodity, such as a precious metal. Fiat currency is currency with a value all of its own, determined by the value that buyers and sellers place on it. The value of commodity currency tends to fluctuate less, but as an economy grows, it typically leads to deflation unless the supply of the commodity to which the government ties it grows at the same pace. The value of fiat currency is something that a government can easily regulate, but reckless governments may sometimes suddenly print exorbitant amounts of currency to pay off debts, thereby destroying the market value of the currency.

Inflation vs. Deflation

Inflation is the decrease of currency value, while deflation is the increase of currency value. Both are potentially harmful for economies, but deflation tends to be more harmful because it retards economic activity by giving people incentive to hold on to their money instead of lending, spending or investing it. For this reason, most countries prefer inflation to deflation, and they use fiat currency to maintain inflation. While the ideal scenario is for a country's level of currency supply to perfectly track total economic growth, thus resulting in an unchanging currency value, governments cannot predict economic growth accurately enough to accomplish this goal. For this reason, they tend to intentionally maintain a low level of inflation to keep deflation from occurring. Such monetary policy results in a gradual, continuous loss of currency value.

Fairness vs. Growth

When it comes to fiscal policy, the basic choice a government must make is whether or not to use taxation to reappropriate wealth. The philosophy behind such action is that many people cannot afford to pay for basic necessities such as food, clothing, shelter, utilities, health care, transportation and education, even when said people work and contribute to the economy. By levying taxes and using the money collected to pay for government programs, governments can redistribute the total wealth of the economy. However, such taxation limits the incentives for innovation and entrepreneurship, thus keeping the economy as a whole from growing as much as it otherwise would, possibly keeping low-level wage growth stagnant as well.

Stability vs. Average Ratio

Various aspects of an economy follow business cycles, which are the repeated ups and downs resulting from economic growth and retraction. One such aspect is unemployment. While low unemployment rates are always better for an economy than high unemployment rates, the volatility of changes in unemployment also affects economies adversely. Governments can take steps to contain volatility, but doing so can result in a less ideal long-term average. In the case of unemployment, countries with extensive unemployment benefits tend to have less volatility in total employment, but with higher average unemployment rates in the long term, while countries with minimal unemployment benefits tend to have more volatility and lower average unemployment rates.

Short Term vs. Long Term

Another aspect of fiscal policy is the matter of choosing between short-term and long-term benefits. For instance, a government may issue a stimulus package to increase economic activity in the short term, but it will have to enact higher taxation and lower government spending in the long term to pay for that stimulus. Conversely, investing in things like education and health care are expensive in the short term, but they may have advantageous long-term effects. In such cases, those in charge of fiscal policy must balance short- and long-term benefits to see which are more important in a given situation.

References

• William F. Hummel: Commodity Money vs Fiat Money, A Unified View
• Federal Reserve Bank of San Francisco; What is deflation, what are the risks of deflation, and how can the Fed combat deflation?; 2003
• Applied Finance and Toreador Research & Trading: Progressive Tax Codes and Economic Growth: Fairness versus Efficiency
• Outside the Beltway; Economic Volatility; Steve Verdon; 2007
• The Wall Street Journal; Our Fiscal Policy Paradox; Alan S. Blinder; 2010
• The Fiscal Times; Bush Tax Cuts Had Little Positive Impact on Economy; Bruce Bartlett; 2010