"A monetary policy rule is preferable to discretionary stabilization policy.

"
Monetary policy conducted by way of rule does have some flaws. One such flaw would
be when a monetarist or politician announces how they are to deal with a particular economic
situation, only to later break their adherence to that plan. By contrast, discretionary
stabilization policy is a more flexible option when dealing with various economic situations.
Discretionary policy works well in volatile economic environments with large fluctuations in
economic indicators such as unemployment, as the central bank can make changes in its policy
multiple times in order to best traverse the economic issues at hand. Given the nature of the
current economic environment, stabilization policy may be favoured over policy rule or vice
versa. In this way, we cannot blindly say that one policy measure is preferable to another.

Compare the traditional view with the view of Ricardian equivalence of the
effects of a debt-financed tax cut on:
i. National saving
Traditional: Less taxes leading to increased consumption through wealth effect.
Increased consumption leads to decreased national saving.
Ricardian: Rational consumers recognize tax-postponements, and increase saving to
prepare for higher future taxation.
ii. Current consumption
Traditional: Less taxes leading to increased current consumption through wealth
effect.
Ricardian: Rational consumers recognize tax-postponements, and increase saving to
prepare for higher future taxation. As such, current consumption is decreased.
iii. The real interest rate
Traditional: Tax cuts leading to increased consumption through wealth effect.
Increased consumption leads t o higher overall price levels in the economy, inflation,
which increases the nominal inflation rate. The real interest rate, however, is
unaffected.
Ricardian: Tax cuts lead to increased saving in the economy. Consumption levels fall.
Real interest rate falls.


For each of the following policies indicate whether the policy is i) a monetary or
a fiscal policy, ii) an active or a passive policy, and iii) a policy by rules or with
discretion:

a) Passive Monetary Policy, by Rule
b) Active Fiscal Policy, by Rule
c) Active Monetary Policy, with Discretion
d) Passive Fiscal Policy, with Discretion
e) Active Monetary Policy, with Discretion