The Usefulness of Monetary and Fiscal Policy as Discretionary Stabilization Tools

Abstract

THE APPARENT INABILrry of the governmental stabilization policies to dampen inflation has rekindled old arguments concerning the relative effectiveness of monetary and fiscal policy. The previous widespread faith in the importance of fiscal policy, demonstrated theoretically by Keynesian models and supported empirically (in most people's opinion) by the postKorean War recession, the success of the 1964 tax cut, and the Vietnam War boom, has been called into question now that the 1968 surtax seems to have had so little effect on aggregate demand. Simultaneously with this decline in the fortunes of fiscal policy has come a new monetarist attack purporting to demonstrate that monetary policy is more important than most people had thought it to be, and that fiscal policy has no effect at all on aggregate demand. Obviously government stabilization strategies depend in an important way on the resolution of this debate. For example, if fiscal policy has no effect on demand, it makes no sense to use it as if it does. Fiscal policy should rather be used to determine the distribution of resources between the public and private sector, the allocation of tax burdens, and other economic goals where it does have an effect. By the same token, if monetary policy is all-important, the central bank should probably tend to be more cautious, or gradual, in its use of monetary instruments. There are two separate empirical issues underlying the debate about the usefulness of monetary and fiscal policies as discretionary stabilization tools. First is the well-known question of the relative strengths of monetary and fiscal policy. Although this question has attracted much attention for the past decade, the issue is as far from being resolved today as it ever was. A whole