In many instances, government spending results in the economy moving to the long run steady state at the expense of higher inflation levels. All too often, the best policy is simply to do nothing, leaving the market to adjust in order get the economy back to the long run steady state level (full employment) at the lowest price level. The problem with government doing nothing is two fold. First they do not want to be seen as not acting, especially during a recession. Secondly, the economic benefits of the government doing nothing (such as during a recessionary period) takes a long time to materialize (given prices in the economy take time to adjust), which is not popular with governments especially if there is an election. There seems to therefore be a tension between the Bank of Canada who wants to achieve price stability first and output stability second, versus the Department of Finance who is more concerned with output stability and employment creation. Class, please outline the costs and benefits of achieving price stability relative to output stability (In your answer be sure to discuss the fact that there is no trade-off between inflation and unemployment in the long run). Be sure to discuss the costs of inflation, the costs and benefits of reducing it and how this compares to reducing unemployment if at all possible. Can a case be made for targeting zero inflation as the primary objective, especially in the long run? If so, what things can governments do to tackle unemployment, especially structural?
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