In this chapter, we review the problem faced by government in adjusting monetary and fiscal policy to the underlying conditions relating to the labor market and the growth of real GDP. There are, to be sure, many goals to which macroeconomic policies can, and should, be applied. Among them are price stability, economic growth, exchange rate stability, and some measure of equity, among others. Here we focus on the problem of calibrating monetary and fiscal policy to keep real GDP at its full-employment level.1
Consider Figure 12.1, also seen in the previous chapter. In Chapter 7, we considered how tax policy affects full-employment output, shown here as point A in Figure 12.1. Reductions in tax rates and welfare ...
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