Reinventing Fiscal Policy
University of Cambridge - Department of Land Economy; Universidad del País Vasco (UPV/EHU)
Malcolm C. Sawyer
Levy Economics Institute; University of Leeds - Leeds University Business School (LUBS)
The Levy Economics Institute Working Paper No. 381
Recent developments in macroeconomic policy, in terms of both theory and practice, have elevated monetary policy while downgrading fiscal policy. Monetary policy has focused on the setting of interest rates as the key policy instrument, along with the adoption of inflation targets and the use of monetary policy to target inflation. Elsewhere, we have critically examined the significance of this shift, which led us to question the effectiveness of monetary policy. We have also explored the role of fiscal policy and argued that it should be reinstated. This contribution aims to consider further that conclusion. We consider at length fiscal policy within the current "new consensus" theoretical framework. We find the proposition of this thinking, that fiscal policy provides at best a limited role, unconvincing. We examine the possibility of crowding out and the Ricardian Equivalence Theorem. A short review of quantitative estimates of fiscal policy multipliers gives credence to our theoretical conclusions. Our overall conclusion is that, under specified conditions, fiscal policy is a powerful tool for macroeconomic policy.
Number of Pages in PDF File: 24
Keywords: fiscal policy, crowding out, Ricardian Equivalence Theorem
JEL Classification: E62, H30
Date posted: July 16, 2003
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