Pitfalls in Contracyclical Policies: Some Tools and Results

Abstract

IT is not generally recognized by economists that where governmental contracyclical policies are concerned common sense is a particularly dangerous tool. Policiesautomatic or notwhich appear to be properly designed may very well turn out to aggravate fluctuations.' Miscalculations on delicate questions of timing or magnitudes can be crucial, and these matters may well be out of the range of competence of the good judgment and experience of most of the practical men who determine or advise on our monetary and fiscal policies. This article describes tools which can be used to deal with at least some simple variants of these problems. Such tools can be particularly useful in indicating the nature of the pitfalls in the area. In particular, I will describe two rather plausible types of contracyclical fiscal policy and show that they can lead to some rather surprising results. i. The model and some contracyclical policies. The discussion assumes that we are living in the world of the Samuelson accelerator-multiplier model.2 It will be recalled that the time path of national income, Y,, in that model is described by the second-order linear difference equation: Y, = consumption + acceleration investment + autonomous investment + net government outlay = kYt_1+c(Yt_Yt2) +A +Gt where k is the marginal propensity to consume and c is the relation of the acceleration principle. In other words, we have: