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The Case for Fiscal Policy

  • Philip Arestis
  • Malcolm Sawyer

This paper reconsiders the case for the use of fiscal policy based on a "functional finance" approach that advocates the use of fiscal policy to secure high levels of demand in the context of private aggregate demand, which would otherwise be too low. This "functional finance" view means that any budget deficit should be seen as a response to the perceived excess of private savings over investment at the desired level of economic activity. The paper outlines the "functional finance" approach and its relationship with fiscal policy. It then considers the three lines of argument that have been advanced against fiscal policy on the grounds of "crowding out." These lines are based on the response of interest rates, the supply-side equilibrium, and Ricardian equivalence. The paper advances the view that the arguments, which have been deployed against fiscal policy to the effect that it does not raise the level of economic activity, do not apply when a "functional finance" view of fiscal policy is adopted. A section on the intertermporal budget constraint considers whether this constraint rules out budget deficits, and concludes that in general it does not.

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Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_382.

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Date of creation: May 2003
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Handle: RePEc:lev:wrkpap:wp_382
Contact details of provider: Web page: http://www.levyinstitute.org

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  1. Philip Arestis & Malcolm Sawyer, 2003. "Reinventing fiscal policy," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 26(1), pages 3-25, October.
  2. Wynne Godley, 1999. "Seven Unsustainable Processes: Medium-Term Prospects and Policies for the United States and the World," Economics Strategic Analysis Archive 99-10, Levy Economics Institute.
  3. Wynne Godley, . "Fiscal Policy To The Rescue," Economics Policy Note Archive 01-1, Levy Economics Institute.
  4. Buiter, Willem H, 2001. "Notes on 'A Code for Fiscal Stability.'," Oxford Economic Papers, Oxford University Press, vol. 53(1), pages 1-19, January.
  5. M. Buti & D. Franco & H. Ongena, 1997. "Budgetary Policies during Recessions - Retrospective Application of the "Stability and Growth Pact" to the Post-War Period," European Economy - Economic Papers 121, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
  6. Robert J. Barro, 1988. "The Ricardian Approach to Budget Deficits," NBER Working Papers 2685, National Bureau of Economic Research, Inc.
  7. Philip Arestis & Malcolm Sawyer, 2002. "Can Monetary Policy Affect The Real Economy?," Economics Working Paper Archive wp_355, Levy Economics Institute.
  8. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  9. Hyman P. Minsky, 1991. "Financial Crises: Systemic or Idiosyncratic," Economics Working Paper Archive wp_51, Levy Economics Institute.
  10. Gerald P. Dwyer, Jr. & R. W. Hafer, 1998. "The federal government's budget surplus: Cause for celebration?," Economic Review, Federal Reserve Bank of Atlanta, issue Q 3, pages 42-51.
  11. Chadha, Jagjit S & Dimsdale, Nicholas H, 1999. "A Long View of Real Rates," Oxford Review of Economic Policy, Oxford University Press, vol. 15(2), pages 17-45, Summer.
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