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Econ 191: April 17, 2011: Fiscal Policy in a Depressed Economy

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.


  1. Lloyd Metzler (1951). "Wealth, Saving, and the Rate of Interest". Journal of Political Economy 59:2 (April), pp. 93-116 http://www.jstor.org/stable/1825743

  2. Gauti Eggertson and Michael Woodford (2002). "The Zero Bound on Interest Rates and Optimal Monetary Policy". Brookings Papers on Economic Activity 2002:1 (Spring), pp 139-211 http://www.ny.frb.org/research/economists/eggertsson/BrookingsPaper.pdf

  3. Gabriel Chodorow-Reich, Laura Feiveson, Zachary Liscow, and William Gui Woolston (2011). "Does State Fiscal Relief During Recessions Increase Employment? Evidence from the American Recovery and Reinvestment Act". Berkeley: U.C. Berkeley (August) http://econgrads.berkeley.edu/gabecr/files/2011/05/Does-State-Fiscal-Relief-During-Recessions-Increase-Employment-August-20114.pdf

  4. Jan Hazius and Sven Jari Stehn (2011). "The Case for a Nominal GDP Level Target". Goldman Sachs U.S. Economic Analyst 11/41 (October 14) http://delong.typepad.com/1014wkly.pdf

  5. Christina D. Romer (2011). "What Do We Know About the Effects of Fiscal Policy? Separating Evidence From Ideology". Berkeley: U.C. Berkeley (November 7) http://www.econ.berkeley.edu/~cromer/Written%20Version%20of%20Effects%20of%20Fiscal%20Policy.pdf

  6. J. Bradford DeLong and Lawrence H. Summers (2012), "Fiscal Policy in a Depressed Economy" http://www.brookings.edu/economics/bpea/Latest-Conference/delongsummers.aspx