During a war, there might be a temporary increase in government spending.
The government could either run a deficit or raise taxes to balance the budget.
Professor Robert Barro of Harvard University believes that it is more efficient to keep tax rates relatively constant than to raise them and then lower them later.
We would like to avoid distortions in economic behavior caused by temporarily raising tax rates to very high levels.
We avoid creating excess distortions in the economy by gradually raising taxes to service the debt.
There were many attempts to balance the federal budget.
Congress was close to passing a balanced budget amendment in 1995 and sending it back to the states.
The amendment was defeated by a single vote in the Senate.
Budgetary constitutional amendments have been proposed.
After a phase-in period, Congress must propose a budget in which total revenues cover total expenditures.
The escape clauses in the amendments allow borrowing during wartime.
Congress can suspend the requirement to balance the budget for other reasons, such as during a recession.
Some versions would limit the rate of spending increases to the rate of GDP growth.
Proponents of the balanced-budget amendment say it will prevent large deficits in peacetime, like the ones that occurred in the 1980s.
The negative effects of defi cits could be avoided with a balanced budget.
A balanced budget may not allow enough flexibility, or room, for the government to effectively deal with recessions, according to critics of a balanced-budget amendment.
Unless three-fifths of Congress votes to suspend requirements, the government would have to cut expenditures or raise taxes during a recession under some versions of the amendment.
This would make the recession worse and limit the government's ability to use fiscal policy to help the economy.
The Constitution isn't the right way to enforce complicated bud get rules.
The courts would become involved in federal budget matters as interested parties challenge the actions of Congress.
Special budgets could be created by Congress to get around the requirement for exam ple, by taking some types of spending "off budget," which means not counting them as part of the official budget.
Congress could use nonbudgetary ways to carry out its policies.
It could impose mandates on businesses or other governments to carry out its will.
The regulations could be more costly to the economy.
The new arrangement was promoted by Alexander Hamilton as a way to strengthen the federal government so that it could borrow as needed.
The states were willing to give the power to the federal government in exchange for forgiveness of their debts.
The federal government did not bail out the states when they got into fiscal difficulties in the 1840s.
The federal government did not want to increase its power and control over the states, which were forced to impose new rules and fiscal discipline on themselves to avoid future fiscal disruptions.
The fiscal structure of the United States was defined by the two episodes.
In 1789, the United States enacted its new Constitution.
The Federal Reserve can play a variety of roles.
Unemployment can be prevented from exceeding the natural rate or falling too far below it if monetary policy is used.
The Fed plays a critical role as a lender of last resort and a unique resource to combat financial crises.
The Congress has expected the Fed and other agencies to play multiple roles.
The Humphrey-Hawkins legislation was passed in 1978 and calls for full employment and price stability as well as balances in the trade and budget.
Money is neutral and monetary policy can't affect the level of output or unemployment.
It is difficult to target the appropriate unemployment rate when the natural rate can shift over time.
The rate of inflation was between 1 and 2 percent in the early years of the twenty-first century.
The time was right for the Fed to focus on keeping the inflation rate low.
They thought the Fed should use monetary policy to target an appropriate inflation rate and keep inflation in check.
There is still concern about long-run inflation following the expansion of the Fed's activities.
Canada, the United Kingdom, New Zealand, Sweden, Australia, and Spain have all adopted various inflation-targeting methods in recent years.
Many developing countries found that targeting inflation helped them fight inflation.
Proponents of inflation targeting have been strong.
Let's take a close look at two important debates about this topic.
In the long run monetary policy can only affect the level of prices, not the level of employment.
Proponents of inflation targeting say the Fed should only have one goal: controlling inflation.
They say that having it worry about other factors distracts it from its mission and leads to long-run inflationary pressures building in the economy.
The credibility of the Fed would be enhanced if it were committed to controlling inflation.
The private sector will be more responsive to monetary policy changes if the Fed is credible.
If the public understands what the Fed is doing, long-term interest rates will be more responsive to changes in short-term rates.
The need for active monetary policies may be decreased by credible policies.
Keeping the Fed free of political pressures would be aided by having a single goal.
Efforts by one political party or the other to boost the economy or give financial markets a temporary boost before an election are examples of political pressures.
Some people who favor inflation targeting hold a less rigid view.
Although they believe fighting inflation should be the primary objective of the Fed, or of a central bank, they believe an inflation-targeting regimen could be designed to give the cen tral bank some flexibility.
The central bank could be required to target a range of inflation between 1 and 3 percent in the future.
There is room for central banks to meet other policy objectives under either of the alternatives.
Many countries allow wiggle room in their inflation targeting by using broad inflation bands or distant targets.
Ben Bernanke was an advocate for inflation targeting before he became chairman of the Federal Reserve.
In 2003 he was a member of the Board of Governors and gave a speech on the merits of inflation targeting.
Inflation targeting provided a long-term anchor for inflation expectations and increased the effectiveness of monetary policy.
As long as the private sector understood the Fed was holding firm to long run inflation targets, it would have added flexibility to use aggressive monetary policy in the short run to offset adverse shocks to the economy.
Under inflation targeting, the Fed could take actions to offset shocks to the financial system, but it had to keep its long-run inflation targets in view.
After the financial crisis of 2008, Bernanke stopped speaking about inflation targeting and devoted his speeches to explaining the Fed's actions during the crisis and designing an "exit strategy" for the Fed's massive interventions.
Janet Yellen, the current chair, is careful to emphasize both inflation and employment.
Prior to the recent recession, many economists disagreed with the idea of inflation targeting because they objected to the Fed concentrating solely on controlling inflation.
In the United States, Congress and the president can't agree on a fiscal policy in a hurry.
Automatic fiscal stabilizers are often not enough to cushion the economy when a shock hits.
Monetary policy can be used to prevent deep recessions from emerging.
If fiscal policies are difficult for Congress and the president to pass, the government has no other tools.
The level for an inflation target is debated by economists.
The ultimate goal should be total price stability, that is, zero inflation.
There are legitimate questions about what constitutes stable prices.
When there is a lot of technological change occurring in the economy, it's hard to measure changes in prices accurately.
Many economists believe that if our price index overstates the true inflation rate, annual inflation of 2 percent may be true price stability.
Concerns about the zero lower bound for monetary policy and the fact that nominal interest rates cannot fall below zero have led to the view that the target inflation rate should be 2 percent.
A higher average inflation rate would allow the Fed more room to lower rates and not run up against the lower bound.
Critics of stabilization policy believe that not using monetary policy to try to stabilization the economy would improve our economic performance.
Over the years, stabilizing the economy has done more harm than good by making fluctuations worse.
There were difficulties in conducting stabilization policy in previous chapters.
There are lags, uncertain ties about the strength and timing of policies, and difficulties in estimating the natural rate of unemployment.
You will think the Fed should only target inflation if you think the difficulties are impossible.
If you think they can be overcome, you will believe the Fed should be allowed to keep stabilizing output and employment.