Why anti-stimulus arguments do not apply

30 January, 2012 at 10:36 | Posted in Economics | Leave a comment
 
Simon Wren-Lewis tells us the main reason why – they ignore the zero lower bound for interest rates: 
 
There are good arguments for saying that if monetary policy is free to do its job, then countercyclical fiscal policy is both unnecessary and welfare reducing. I have written on the subject. But having written those papers, I could see immediately the importance of that proviso about monetary policy. At the zero lower bound for interest rates (in a liquidity trap), monetary policy is clearly not free to do its job, and so different conclusions apply. See Eggertson and Woodford (2004). If the argument assumes that, despite the zero bound, monetary policy can do all that is required, then this should be said so explicitly, because it is somewhat counterfactual.
 
For exactly the same reasons, these arguments against countercyclical fiscal policy do not apply to individual countries in a monetary union. If monetary policy is set by the ECB, it cannot ensure output is at its natural level (‘full employment’) in each individual Eurozone country. There is a large literature on this, which I have contributed to, but a standard reference would be Gali and Monacelli (2008). There, as in most of this literature, countercyclical fiscal policy in the face of country specific shocks is welfare improving.
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