Grasping Reality on TypePad, by Brad DeLong

Download 20120417 econ 191 fiscal policy in a depressed economy

Five years ago, there was a near-complete consensus that aggregate demand management was the exclusive province of central banks and their conventional open-market operations. Problems of legislative process of implementation meant that fiscal policy worked more slowly than conventional monetary policy. Even should an economy find itself in a liquidity trap, whatever that means, credible commitments by central banks to hit future nominal spending and nominal exchange rate targets still seemed to dominate fiscal policy.

Today because we are in a depressed economy we think differently. Or do we? How differently do we think, and why?

Suggestions that we should move away from exclusive reliance on central banks and conventional open-market operations in a liquidity trap have three possible justifications:

• Our uncertainty about what is the right model of the economy.
• Our belief that conventional open-market operation monetary policy tools weaken in situations like the depressed economy of the present--that in a depressed economy there is a lack of power on the part of central banks.
• A possible lack of will on the part of central banks: a belief on the part of central bankers that while spending flows ought to be higher, it ought to be elected governments that take steps to make it so.