Reinventing Fiscal Policy

There has been a major shift within macroeconomic policy over the past two decades or so in terms of the relative importance given to monetary policy and to fiscal policy, with the former gaining considerably in importance, and the latter being so much downgraded that it is rarely mentioned. Monetary policy has focused on the setting of interest rates as the key policy instrument, along with the adoption of inflation targets and the use of monetary policy to target inflation. The Central Bank sets its discount rate2 with a view to achieving the set inflation target, but the discount rate can be considered as set relative to an ‘equilibrium rate’ so that the problem of aggregate demand deficiency appears to be effectively dispensed with.3 This can be seen in the operation of Taylor’s rule for the setting of the discount rate (Taylor, 1993). In Arestis and Sawyer (2003a), we critically examine the significance of this shift in terms of monetary policy, which led us to question the effectiveness of monetary policy. In the same paper we also explore the role of fiscal policy, and argue that within the ‘new consensus’ there is barely mention of fiscal policy.4 We strongly suggest there that fiscal policy should be reinstated, and conclude that ‘fiscal policy remains a potent tool for offsetting major changes in the level of aggregate demand’ (p. 19). This chapter aims to consider further that particular conclusion (see also, Arestis and Sawyer, 1998).