Symposium Introduction: Monetary and Fiscal Policy in Theory and Practice

Abstract

At 1997 Annual Meeting of American Economic Association five eminent but diverse economists participated in a symposium on whether there is a core of practical macroeconomics that could be confidently used, especially to underpin macroeconomic policy. The papers were published as Blanchard (1997), Blinder (1997), Eichenbaum (1997), Solow (1997) and Taylor (1997). Given diversity of five there is a remarkable degree of agreement. All five agree that in long run there is no trade off between unemployment and inflation and that trend movements in real variables such as output, employment and unemployment are determined by supply side. Aggregate demand has little place in long run analysis. As Solow put it, the appropriate vehicle for analysing trend motion is some sort of growth model, preferably mine (1997, p. 230). There is also agreement that in short run, due to wage and price rigidities and perhaps expectation factors, monetary policy can and does affect levels of output, employment and unemployment. Moreover, there is a short run trade off between unemployment and inflation. Views on how to balance costs of unemployment against cost of inflation can be expected to vary among economists, but since monetary policy is in hands of central bankers, generally a conservative group of people, most weight is given to keeping inflation rate low. In a number of countries this goal is explicitly made major responsibility of central bank. In Australia Government has given in writing Reserve Bank a target for inflation but no other explicit targets, although unemployment is ranked equally with price stability as goals in legislation establishing Reserve Bank. The five economists also agree that in short run fiscal policy as well as monetary policy can influence output, employment and unemployment, though their theoretical reasons for this differ. Eichenbaum argues that discretionary fiscal policy is desirable nor politically feasible (1997, p. 236), since long lags in implementation (in United States, at least)1 may make use of fiscal policy counterproductive. Also there are worries about use of expansionary fiscal policy when level of public debt is high. In Australia neither of these objections carry much weight. Fiscal policy measures can be, and have been, introduced whenever thought desirable and not just in annual budget. Moreover, expansionary fiscal policy measures usually are approved without delay by both Houses of Parliament. Eichenbaum's statement about undesirability of fiscal policy may reflect a widespread concern about use of expansionary fiscal policy when there is a high level of public debt. In Australia public debt is so small as to be virtually non-existent. This core of macroeconomics has become known as new consensus or new neoclassical synthesis. It is described in more detail in articles in this symposium by Hart and by Kriesler and Lavoie. Hart goes further and sets out in detail theoretical structure on which new consensus is based. Both articles are highly critical of this new consensus. The discussion may sound like a doctrinal discussion among economic theorists. But it does affect policy making in real world. As Blinder points out, this sort of discussion potentially affects well-being of hundreds of millions of people around globe (1997, p.243). The article by Kriesler and Lavoie is a critique of this new consensus, or new neoclassical synthesis, that draws particularly on work of Post Keynesian economists.2 Kriesler and Lavoie reject conclusions of new consensus about relationship between unemployment and inflation in both short run and long run. They argue that, over a large range of unemployment rates, changes in rate of unemployment have no effect on rate of inflation. Moreover, level of economic activity is often such that unemployment is in this range. …