Effective Demand Failures and the Limits of Monetary Stabilization Policy
American Economic Review
vol. 112,
no. 5, May 2022
(pp. 1475-1521)
Abstract
The challenge for stabilization policy presented by the COVID-19 pandemic stems above all from disruption of the circular flow of payments, resulting in a failure of what Keynes (1936) calls "effective demand." As a consequence, economic activity in many sectors can be inefficiently low, and interest-rate policy cannot eliminate the distortions—not because of a limit on the extent to which interest rates can be reduced, but because interest-rate reductions fail to stimulate demand of the right sorts. Fiscal transfers are instead well suited to addressing the fundamental problem, and can under certain circumstances achieve a first-best allocation of resources.Citation
Woodford, Michael. 2022. "Effective Demand Failures and the Limits of Monetary Stabilization Policy." American Economic Review, 112 (5): 1475-1521. DOI: 10.1257/aer.20201529Additional Materials
JEL Classification
- E23 Macroeconomics: Production
- E32 Business Fluctuations; Cycles
- E43 Interest Rates: Determination, Term Structure, and Effects
- E52 Monetary Policy
- E62 Fiscal Policy
- E63 Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
- H63 National Debt; Debt Management; Sovereign Debt