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16 -- Part 5: The Dynamics of Inflation
Some economists like the idea of the Fed having to meet targets, but they have suggested alternatives to inflation targeting.
John Taylor developed an approach that has wide appeal.
Taylor suggested that the Fed follow a rule that keeps a long-run inflation target but allows the Fed to raise or lower interest rates depending on whether output is above or below potential.
His analysis shows that the Fed's performance would be better if it followed a rule like this.
The advantage of a rule like this is that it allows the Fed to offset shocks to the economy, but requires the Fed to meet long-run inflation targets.
The idea is that the Fed would target the price level, which would grow, at the inflation rate of 2 percent per year.
For example, if inflation was less than its target for a period of time, it would be 1 percent instead of 2 percent.
The price level grew less than 2 percent and was below its trend.
To reach its price-level target, the Fed would have to temporarily raise inflation above 2 percent.
It could be required to cause inflation to reach 3-4 percent until the economy reaches its earlier price-level target.
Under inflation targeting, the Fed would have to raise its inflation rate back to its 2 percent target and not go any higher.
Proponents of price-level targeting believe it will balance the goals of employment and price stability.
Critics believe that the Fed is at risk of allowing inflation to exceed its target as it may prove difficult to reduce inflation at a later time.
Several important questions would remain even if the United States adopted inflation targeting as a policy.
The inflation target for the central bank is decided by the elected govern ment in the United Kingdom.
The range for the inflation rate that the bank must meet is specified by these elected officials.
Taylor found that the Fed was too aggressive in lowering interest rates.
Interest rates dropped from 2 percent in 2001 to 1 percent in 2004.
The Fed would have raised interest rates to 4 percent by 2004, a very significant deviation from past experience.
If the Fed had not followed its easy money policy, housing starts would have been much lower.
The boom and bust would not have happened.
Taylor looked at the experiences of European countries.
The Fed's same phenomenon was argued by John Taylor.
Spain experienced the worst of the housing boom in the decade that ultimately boom and bust cycles for housing due to the Taylor rule.
Exercise 2.7 is related to it.
The Taylor rule was used to analyze the Fed's behavior.
He showed that the Fed's SOURCE was based on John B. Taylor's "An Empirical Analysis of What Went Wrong."
Applying this model to the decade of 2000 allows it to present its views to the public through its publications and published minutes of its meetings.
The final decision is made by the elected government.
The central bank has more power in setting the inflation target in other countries.
In New Zealand, the central bank has the responsibility of achieving and maintaining stability in the general level of prices without any competing goals.
The law requires the head of the central bank and the finance minister to negotiate inflation goals.
The Fed has considerable power to use monetary policy to fight inflation, even though it is not required to report regularly to Congress.
Changing our current system would require major decisions about who has authority and control over our economic system.
The Fed has a lot of power.
Congress and the president could end up with more power over monetary policy if inflation targeting makes the Fed more independent.
That could lead to more inflation.
The United States has a low saving rate.
Investment spending deters income and consumption taxes, which hurts our long-run growth prospects.
Many factors contribute to our low saving rate.
Colleges give less financial aid to students whose families have saved for their education.
Programs cut the benefits of families who have saved in the past and still have money left in their accounts.
Savings are discouraged by the U.S. tax system.
You have to pay taxes on both your wages and your savings in the United States.
You have a tax rate of 20 percent if you earn $100 at your job.
After taxes, you keep $80.
Say you save $50 and invest it at 10 percent.
At the end of 1 year, you will have earned an additional $5 on the $50 you saved, but you will only get to keep $4 of it because the government will take 20% of it.
You will have to pay the government $21 in total, which includes $20 on the $100 you earned in wages, plus $1 on the $5 you earned on your savings.
You would pay $21 in taxes if you didn't save at all.
Some tax systems don't work this way.
Tax systems based on consumption don't penalize people who save.
It is possible to create a con Taxes based on the consumption, not the tax from an income tax, just as we do income of individuals.
The government could allow savings to be deducted from gross income before calculating total taxes owed.
If you decide to save more of your income, you won't face additional taxes.
There are ways to save money in the United States.
In addition to buying tax-exempt bonds, you can also invest in an IRA or 401(k), which are types of retirement accounts.
The money in pension funds is treated the same.
The person who contributed it doesn't have to pay taxes until they retire.
The tax rate that people pay on the money they draw from these accounts is lower than when they saved it because they earn less money during retirement.
The money accumulates more quickly if it's in these accounts.
Proponents claim that taxes based on consumption will increase total savings.
Let's look at the claims.
There is no question that taxing consumption creates an incentive to save.
There is no guarantee that the incentive will result in more money being saved in the economy.
Reducing the tax rate on savings would shift the tax burden to consumption.
People will want to take advantage of this incentive to increase their savings and reduce their consumption.
The tax cut will make people want to spend more.
There has been a lot of research done on how a consumption tax would affect savings.
Individuals will cate their savings to tax-favored investments over investments that are not favored.
They will put money into their IRAs.
It's not clear if the funds will be new savings or just transfers from other accounts, which don't have the same tax advantages.
It is difficult to untangle these effects, and they remain an active area of ongoing research.
Corporations in the United States have a tax system that makes it difficult to save and invest.
You can purchase a share of stock in a corporation.
When a corporation makes a profit, it pays taxes at the corporate tax rate.
When the corporation pays you a dividend on the stock, you have to pay taxes on the income that you receive.
Corporate income is taxed twice, first when it is earned by the corporation and then when it is paid out to shareholders.
Some economists argue that the corporate taxes lead to less efficient investments because they result in capital flowing into other sectors of the economy that don't suffer from double taxation.
President Bush introduced a bill in 2003 that lowered taxes but did not eliminate them.
The idea of a consumption tax seems fair.
Individuals should not be taxed on what they consume, but on what they take away from the economy's total production.
If an individual produces a lot but doesn't consume the money they get from it and instead plows it back into the economy for investment, they should not be punished.
Individual A earns $50 and consumes it all, while individual B only consumes 40.
The distribution of income in the economy could be affected by moving to a consumption-tax system.
We could just exempt the returns from the income tax.
Wealthy and high income individuals who save the most and earn a lot of income in interest, dividends, rents, and capital gains would be favored by this exception.
Estimates are based on capital gains received by different income classes and dividends paid by corporations.
Taxpayers with annual incomes over $1,000,000 earn profits when they sell over half of the economy's capital gains and dividends.
The government would have to raise tax rates on everyone to maintain the same level of spending if capital gains and other types of capital income were not taxed.
Excluding capital income from taxation has costs.
It is important that high-income individuals pay their fair share of taxes, according to some economists.
Superstar athletes, famous actors and musicians, CEOs, and successful entrepreneurs have all earned large fortunes as the distribution of income has become more equal in the last several decades.
The tax system can be used to reduce inequalities in income.
Consumption taxes worry that moving our tax system in that direction will take away an important tool for social equality.
Other economists believe that high-income individuals already shoulder a high share of the total tax burden and that we need to focus on designing an efficient system to promote economic growth.
Proponents of consumption taxes have tried different ways to meet the challenge of fairness.
The personal income tax and corporate income tax are brought into a single, unified tax system by the "flat tax" designed by Robert E. Hall and Alvin Rabushka of the Hoover Institute.
Businesses deduct wage payments from their taxes.
They can deduct investment spending from their income before the tax is calculated.
Allowing a deduction for savings has the same effect as allowing a deduc tion for investment.
A consumption tax is a type of flat tax.
An important feature of this version of the flat tax is that wealthy indi viduals and other owners of corporations still pay taxes.
The corporation or business might make an extraordinary return on its investment.
Consider the enormous profit generated by Apple's iPad.
Over 200 million iPads have been sold.
If the profit for each iPad was $100, Apple's total profit would be $22.5 billion.
These gains would be taxed in full under this version of the flat tax.
If the owners of a corporation earn extraordi nary gains, they will pay taxes on them.
The projected federal deficit has led many policymakers to consider whether a European-style value-added tax would make sense in the United States.
It would be difficult to get a VAT on to the U.S. fiscal system.
The basic VAT rate in the United Kingdom is 17 percent.
The VAT has advantages.
The consumption tax does not penalize savings.
There are possible difficulties.
Almost all developed countries have coun authority.
Conservatives worry that it is also trying to have a value-added tax.
The efficient and consumers don't pay taxes.
The United States is an exception.
Liberals worry that the VAT, like all consumption taxes, could be a sales tax that is levied on each stage of production.
Firms pay more than others.
An old joke says that liberals will get a credit for VAT paid when they realize it is a money machine and conservatives will get a credit for VAT paid when they realize it is a money machine.
VAT is embedded to recognize that it is a regressive tax.
Exercise 3.7 is related to it.
When goods are exported chapter summary and problems are included, it is rebated.
Deficits can be good for the country.
It leads to inflation.
386 e x e r C I S e S all problems are assignable in MyLab Economics.
List the benefits and costs of running a deficit.
If a government runs a deficit, it will be in favor of the policy and one argument against it.
If taxes are raised in the pressure of an aging population and increases in the future, cits don't really matter.
Government deficits can be financed by borrowing in the future.
If a government finances its deficits by creating new taxes, the result will be a decrease in taxes.
If you believe that Congress will spend whatever revenue it collects, then imagine if future spending increases are not for Belgium in 1989.
The data can be used to answer the following questions.
How do the ratios compare to the surplus?
If Bel summarizes the arguments in favor of inflation targeting.
Suppose they fight inflation.
Inflation targeting is the same as price-level targeting.
Capital gains accrue to low-income individuals.
Instead of inflation targeting, a traditional IRA is used.
Suppose your tax rate is 50 percent and you deposit $2,000 into an IRA.
Those econo ceeds double in seven years to $4,000, but the pro want a higher inflation rate.
mists who don't worry about the zero lower bound are retired.
Taking into account your tax deduction for the IRA, the Federal Reserve should follow strict rules for how much you invested in the IRA.
You don't get a deduction for information that is fully available to the public, but the interest you earn is tax-free.
If you put $1,000 into the traditional IRA for 7 years, the Fed would put it on autopilot.
The United States does not have a VAT.
There is a consumption tax.
The tax will be the same.
A sales tax that is levied at all stages of production is called a(n) tax.
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