Revival of Aggregate Demand Policies - Introduction

Abstract

This issue contains a selection of the papers presented at the workshop “The Revival of Aggregate Demand Policies: Back to Keynes” that took place in Venice in July 2004. During recent years, there has been growing consensus that monetary policy can work as an effective stabilisation mechanism. Using formal (dynamic) general equilibrium models based on micro-foundations, the so-called New Keynesian approach – the workhorse of modern macroeconomics – provides sophisticated tools for exploring the implications of monetary policy. Whereas the academic literature, until recently, focused mainly on monetary policy, it is now paying increasing attention to the fiscal side of aggregate demand management. This conference issue aims to provide a critical appraisal and extension of that literature, focusing both on fiscal and monetary aspects. Recently, fiscal policy has become popular again among policymakers as a stabilisation tool. Tax cuts in the U.S. have been partly motivated by the argument that they would stimulate the economy by increasing demand. Similarly, the protracted sluggishness of the German and French economies has led to tax reductions. Given that in the Euro Area monetary policy no longer responds to national shocks, many call for a stronger role of fiscal policy as a stabilisation tool. Not so long ago the French President Chirac and the German Chancellor Gerhard Schroder jointly called for setting up large infrastructural projects to revive the European economy. While such projects affect the supply-side in the longer run by boosting European productive capacity, the short-run effect would be an increase in employment, hence income and spending, and thus a boost to aggregate demand. For a long time, academic researchers have been sceptical about aggregate fiscal demand management on the ground that fiscal fine-tuning is impossible due to decision and implementation lags, as well as uncertainty about the way the economy works. But their interest in the effects of fiscal policy impulses has recently been revived. Samples of recent contributions are Burnside et al. (2003), who look at the effects of major shocks to military spending in the U.S., Blanchard and Perotti (2002), who use detailed institutional information