conflict theories

Topics: Inflation, Monetary policy, Keynesian economics Pages: 9 (3163 words) Published: December 1, 2013
The Limits of Monetary and Fiscal Policy
John H. Makin | Economic Outlook
July 14, 2011
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July 2011
Following two rounds of monetary and fiscal stimulus, we are relearning that neither monetary nor fiscal policy is likely to have long-lasting effects on growth or unemployment. The tepid growth of US output and employment in response to two rounds of monetary and fiscal stimulus since 2008 suggests that a third round of either monetary or fiscal stimulus in 2011 would lead primarily to higher inflation and a higher ratio of government debt to gross domestic product (GDP) in 2012. Key points in this Outlook:

Monetary policy has reached its limits. The significant risk of deflation that prompted last year's second round of quantitative easing has passed, and with inflation rising, monetary stimulus is no longer an option. Two rounds of fiscal stimulus have produced neither a sustained rise in growth nor a sustained drop in the unemployment rate. Another round would merely increase deficits and debt levels. Rather than enacting further stimulus, the Federal Reserve should aim for lower, steadier inflation, and Congress and the president should cut spending and reduce tax expenditures to finance lower tax rates and reduce the debt-to-GDP ratio. US growth slowed during the first half of 2011 while the sovereign-debt crisis ebbed and flowed and unsettled financial markets, just as occurred in the second quarter of 2010. It is no surprise under these circumstances that the Fed has been under pressure to initiate another round of quantitative easing or that the White House, former Treasury secretary Lawrence Summers, former chair of the President's Council of Economic Advisers Laura Tyson, and former vice chairman of the Federal Reserve Alan Blinder have suggested the need for another fiscal stimulus package. While rising core inflation has appropriately engendered hesitancy on a third round of quantitative easing, rising federal debt has--also appropriately--done the same for fiscal stimulus. If stock markets fall again or unemployment rises further or even stays the same, expect calls for more stimulus to grow louder. Nevertheless, after two rounds of monetary and fiscal stimulus since 2008, the time has come to ask whether we have reached the stage of diminishing marginal benefits from returning to either approach. The recent rise in core inflation suggests that we are approaching the stage of negative returns for further monetary stimulus, while the alarming rise in government debt signals that the same may be true of further fiscal stimulus. This is not to say that an abrupt reversal of the Fed's second round of quantitative easing and a boost in interest rates, along with a trillion-dollar cut in government spending over the next year, would make the economy better off. Such measures would risk a global depression. But it is time to recognize that monetary policy cannot do much more than avoid deflation while keeping inflation low and stable. For its part, fiscal policy can stabilize growth and employment while providing a temporary boost when private demand slows, and conversely tightening--and thereby reducing debt--when private demand overheats. Because monetary and fiscal policy are countercyclical, their impacts on growth and employment are temporary and tend to be reversed once they are withdrawn. In 2011, after repeated rounds of fiscal and monetary stimulus, would efforts to boost the economy or support asset prices with additional stimulus of either kind be endeavors where the long-run present discounted value of the costs outweighs the short-run benefits? Consider some relevant history. After the volatility of the 1970s and early 1980s, US policymakers broadly employed...
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