Confidence, Credibility and Macroeconomic Policy.

• Author: Cate, Tom

By Richard C. K. Burdekin and Farrokh K. Langdana.

New York: Routledge, 1995. Pp. 169. $65.00.

You tell your child, "If you do not stop pestering your brother, you will be in time out for 10 minutes." If the activity continues and you do not put your child into time out, then you lose your credibility with your child. To regain that lost credibility, to regain that lost authority is a very difficult task. This parent-child parable can be retold in terms of a government-private sector setting. This book is about what governments can do to regain the credibility that they have lost with the private sector over the issue of activist macroeconomic policy.

The first three chapters examine the policy irrelevance theorem: In the long-run, activist macroeconomic policies are neutral with respect to real output and employment and nonneutral with respect to the rate of inflation. Chapter 1 states that government expenditures may be funded by taxes, bonds, printing money, or some combination thereof. Any attempt to cover expenditures that are not credible in the eyes of the private sector leads to inflation. Chapter 2 presents a brief summary of the Ricardian Equivalence Theorem and a classroom experiment that illustrates the principal conclusions of this Theorem. In particular, this chapter is concerned with what happens when a government switches from the use of taxes to the use of bonds as the primary means of funding its deficit. Chapter 3 presents a brief summary of Lucas's "Islands Model" and a classroom experiment that illustrates the principal conclusions of this work. In particular, this chapter is concerned with what happens to private sector expectations when the government changes its monetary policy regime.

The next three chapters review three historical instances where governments have funded their deficits by printing money. Chapter 4 reviews the case of hyperinflation that occurred in the Confederacy during the Civil War. During the early stages of the war, the rate of inflation was significant but not unexpected given a war-time economy. After the battle of Sharpsburg in 1862, however, hyperinflation occurred because the Confederate government's policy of funding its war-time expenditures primarily by printing money was not credible in the eyes of the private sector and therefore a flight from currency took place. Thus, by April 1865, the Index of Quarterly Wholesale Prices (April 1861 = 100) had increased to 9211. Chapter 5 reviews...