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Abstract
The paper focuses on short run macroeconomic dynamics triggered by demand side shocks. In particular, the paper analyzes, in a general equilibrium framework, the impact of transitory demand side shocks on the behavior of macroeconomic variables and examines the relevance of policy instruments during downturns in economics activity. The paper establishes that transitory shocks can have persistent effects. It shows that stabilization is desirable even if shocks are transitory in nature. In particular, the article reveals that debt financed government spending is a viable stabilization tool and can improve welfare at all horizons even though it inhibits physical capital formation. Finally, the paper resolves apparently contradictory observations and shows that recessions are simultaneously times of cleansing and sullying.
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