Tools of choice for fighting recessions

Abstract

Policy makers are perpetually reinventing the wheel. Before the First World War, monetary policy was the sole tool used for macroeconomic stabilisation. The ‘Keynesian’ revolution heralded a major change, so that in the first twenty five years after World War II, fiscal policy became the primary tool for economic stimulation. After the experience of stagflation in the 1970s, fashion changed, and monetary policy came into its own. Its perceived importance for policy continually increased until, during the 1990s, it had totally replaced fiscal policy in the minds of policy makers and business interests.1 There has been a major swing in the views of economists interested in and knowledgeable about macroeconomic policy. The majority of such economists now look to monetary policy to cure recessions, whereas fifty years ago the majority thought monetary policy was of little use by itself, though it had a supporting role to play to fiscal policy. Has the world changed, or were most economists mistaken either fifty years ago or now? “Many economists think that using monetary policy in a recession is like pushing on string.” Howard S. Ellis, 1954 (from lecture notes taken by J.W. Nevile at the University of California at Berkeley) “Almost all economists agree that monetary policy, not fiscal policy, is the tool of choice for fighting recessions.” (Paul Krugman, Sydney Morning Herald, 12 January 2001).