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The Macroeconomic Role of Fiscal Policy

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  • Christopher Allsopp
  • David Vines

Abstract

This article examines the new consensus that fiscal policy should have no macroeconomic role in 'flexible inflation targeting' regimes. There is little basis for this presumption. Fiscal policy remains important in setting the policy mix and in managing shocks and imbalances. The credibility of an inflation-targeting regime should be enhanced rather than reduced if fiscal policy plays its proper role. It is true, nevertheless, that the costs of focusing fiscal policy narrowly on public-sector concerns may not be very great, most of the time. However, when interest rates cannot be used, the role of fiscal policy must be different. With interest rates at their lower bound of zero, there is no plausible alternative. For asymmetric shocks and adjustments in EMU, fiscal policy needs, ideally, to substitute for the interest-rate policy reaction function of the consensus, but the difficulties are very great. We suggest a policy focus on real exchange rates as a way of resolving some of the dilemmas. There is a serious danger that orthodox views about fiscal policy, drawn from the consensus, will be inappropriately applied, especially in Europe. Copyright 2005, Oxford University Press.

Suggested Citation

  • Christopher Allsopp & David Vines, 2005. "The Macroeconomic Role of Fiscal Policy," Oxford Review of Economic Policy, Oxford University Press, vol. 21(4), pages 485-508, Winter.
  • Handle: RePEc:oup:oxford:v:21:y:2005:i:4:p:485-508
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    Cited by:

    1. repec:spr:empeco:v:53:y:2017:i:4:d:10.1007_s00181-016-1177-2 is not listed on IDEAS
    2. Bowen, Alex & Stern, Nicholas, 2010. "Environmental policy and the economic downturn," LSE Research Online Documents on Economics 37589, London School of Economics and Political Science, LSE Library.
    3. Pavlina R. Tcherneva, 2008. "The Return of Fiscal Policy: Can the New Developments in the New Economic Consensus Be Reconciled with the Post-Keynesian View?," Economics Working Paper Archive wp_539, Levy Economics Institute.
    4. Ackon, Kwabena Meneabe, 2013. "Effect of Fiscal Policy Shocks in Brazil," MPRA Paper 72534, University Library of Munich, Germany.
    5. Carlin, Wendy & Soskice, David, 2007. "Reforms, Macroeconomic Policy and Economic Performance in Germany," CEPR Discussion Papers 6415, C.E.P.R. Discussion Papers.
    6. Pusch, Toralf, 2007. "Verteilungskampf und geldpolitische Sanktion
      [The struggle over distribution and monetary sanction]
      ," MPRA Paper 15228, University Library of Munich, Germany.
    7. Tania Ajam & Aron Janine, 2007. "Fiscal Renaissance in a Democratic South Africa," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 16(5), pages 745-781, November.

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