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Macroeconomic policy in light of the credit crunch: the return of counter-cyclical fiscal policy?

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  • Simon Wren-Lewis

Abstract

This paper begins by arguing that the 2007-8 credit crunch does not require a fundamental re-evaluation of monetary policy. The crunch occurred because regulation was too lax, and we need to develop new and more effective tools of regulatory control. To focus on current account imbalances or mistakes in setting interest rates as a prime cause of the credit crunch is unconvincing, and has the danger of diverting attention away from the need to increase financial regulation. The current recession does require a re-evaluation of the role fiscal policy can play when interest rates hit a zero bound. An expansionary fiscal policy is required because monetary policy-makers are reluctant to promise higher future inflation, and the impact of quantitative easing is likely to be small. Although rising debt may place a limit on how much conventional fiscal policy can do, not all expansionary fiscal measures require additional borrowing. There are two important lessons for the future. First, although monetary policy should remain the primary tool to stabilize the business cycle, the combination of fiscal implementation lags and uncertainty means that some precautionary fiscal action may be appropriate during the early phase of some economic downturns. Second, to play this 'backstop' stabilization role effectively, a policy that results in the government debt-to-GDP ratio declining (albeit gradually and erratically) in normal times seems appropriate. Copyright 2010, Oxford University Press.

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  • Simon Wren-Lewis, 2010. "Macroeconomic policy in light of the credit crunch: the return of counter-cyclical fiscal policy?," Oxford Review of Economic Policy, Oxford University Press, vol. 26(1), pages 71-86, Spring.
  • Handle: RePEc:oup:oxford:v:26:y:2010:i:1:p:71-86
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    File URL: http://hdl.handle.net/10.1093/oxrep/grp034
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    Cited by:

    1. George Economides & Apostolis Philippopoulos & Petros Varthalitis, 2016. "Monetary Union, Even Higher Integration, or Back to National Currencies?," CESifo Economic Studies, CESifo, vol. 62(2), pages 232-255.
    2. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2015. "Optimal fiscal and monetary policy action in a closed economy," Economic Modelling, Elsevier, vol. 48(C), pages 175-188.
    3. repec:eee:dyncon:v:83:y:2017:i:c:p:55-106 is not listed on IDEAS
    4. Philippopoulos, Apostolis & Varthalitis, Petros & Vassilatos, Vanghelis, 2017. "Fiscal consolidation and its cross-country effects," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 55-106.
    5. Lars Calmfors & Simon Wren‐Lewis, 2011. "What should fiscal councils do?," Economic Policy, CEPR;CES;MSH, vol. 26(68), pages 649-695, October.
    6. Daniele Franco (editor), 2012. "Rules and institutions for sound fiscal policy after the crisis," Workshop and Conferences 11, Bank of Italy, Economic Research and International Relations Area.
    7. repec:ijc:ijcjou:y:2017:q:4:a:8 is not listed on IDEAS
    8. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2013. "Optimal Fiscal Action in an Economy with Sovereign Premia and without Monetary Independence: An Application to Italy," CESifo Working Paper Series 4199, CESifo Group Munich.
    9. George Economides & Apostolis Philippopoulos & Petros Varthalitis, 2015. "Incentives to Work and Performance in the Public Sector," CESifo Working Paper Series 5193, CESifo Group Munich.
    10. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2017. "Fiscal Consolidation in an Open Economy with Sovereign Premia and without Monetary Policy Independence," International Journal of Central Banking, International Journal of Central Banking, vol. 13(4), pages 259-306, December.
    11. George Economides & Hyun Park & Apostolis Philippopoulos & Stelios Sakkas, 2015. "On the Composition of Public Spending and Taxes," CESifo Working Paper Series 5510, CESifo Group Munich.
    12. Apostolis Philippopoulos & Petros Varthalitis & Vanghelis Vassilatos, 2012. "On the optimal mix of fiscal and monetary policy actions," Working Papers 150, Bank of Greece.
    13. J.E. King, 2011. "Four Theses on the Global Financial Crisis," Chapters,in: The Global Financial Crisis, chapter 7 Edward Elgar Publishing.

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