Early and recent debates on the role and efficiency of fiscal policy in stabilization of the economies

Georgieva Svrtinov, Vesna and Fiti, Taki (2011) Early and recent debates on the role and efficiency of fiscal policy in stabilization of the economies. Macedonian Academy of Sciences and Arts.

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Abstract

The paper elaborates, in a sublimated form, the most important open questions, dilemmas and controversies regarding the role and significance of fiscal policy in stabilization of the economies – from Keynes until today. The consensus on the primary role of fiscal policy in stabilization of economies, advocated in the basic Keynesian macroeconomic model, continued to exist with the neoclassical synthesis, even though its authors (primarily Samuelson, Tobin and Modigliani) were eclectics and did not underestimate the significance of monetary policy in stabilization of the economies. The paper underlines that this consensus was abandoned with the emergence of three important new classical concepts (the Lucas critique, the hypothesis on ineffectivenss of discretionary macroeconomic policies and the hypothesis on time inconsistency of policies), which questioned the efficiency of discretionary macroeconomic policies (fiscal and monetary) and significantly influenced the new keynesian concepts of the role of policies in stabilization of economies. The pre-crisis conensus (before the 2007/2008 crisis) was that monetary policy has the prime role in alleviating the economic fluctuations and that fiscal policy, due to the long internal time lag and facing a political choice, should act only through the work of automatic stabilizers or should be based on long-term rules. The paper also points out that the world economic crisis of 2007/2008 dramatically tested the power of governments and fiscal policy in handling deep and prolonged recessions. The post-crisis debates within the mainstream modern macroeconomics, on the role of fiscal policy, intensified again. New classics remind that economies, in the long run, tend to function on the level of potential gross domestic product and reach full employment. Today, they raise their voice against the large fiscal deficits which crowd out the private sector from the economic activity, and which, along with the expansionary monetary policy, drive the economies into a high inflation zone. According to them, large budget deficits that need to be financed “destroy the confidence in markets” and cause abstinence of private investors due to expectations related to the negative implications of fiscal and monetary expansion. New Keynesians, on the other hand, underline that fiscal stimuli prevented a double trough of the economic cycle and secured economic recovery. Therefore, they advocate redefining of the pre-crisis consensus on the role of fiscal policy. In addition, New Keynesian suggestions emphasize (1) the need for maintaining the public debt in normal limits in good times in order to leave enough space for fiscal policy to act in times of economic disturbances; (2) the need for improving the effectiveness of automatic stabilizers of fiscal policy by increasing the progressive character of tax policy and by establishing more generous social insurance programs – especially for the part of the population with higher marginal propensity to consume; (3) the fiscal policy has a longer internal, but shorter external time lag, due to which it is necessary for the role of the public sector and fiscal policy to be explicitly included, with separate equations, in econometric models that reflect the so called New Consensus Macroeconomics, and for the fiscal policy to receive the same treatment as monetary policy; (4) the fiscal policy, in coordination with monetary policy, may have an important role in preventing the episodes of bonanza and sudden stops in situations of financial crises.

Item Type: Article
Subjects: Social Sciences > Economics and business
Divisions: Faculty of Economics
Depositing User: Vesna Georgieva Svrtinov
Date Deposited: 04 Feb 2013 15:24
Last Modified: 04 Feb 2013 15:24
URI: http://eprints.ugd.edu.mk/id/eprint/5461

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