Effective Demand Failures and the Limits of Monetary Stabilization Policy
American Economic Review · 2022 · Volume 112 · Issue 5
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.
Keywords
Macroeconomics: Production, Business Fluctuations, Cycles, Interest Rates: Determination, Term Structure, and Effects, Monetary Policy, Fiscal Policy, Comparative or Joint Analysis of Fiscal and Monetary Policy, Stabilization, Treasury Policy, National Debt, Debt Management, Sovereign Debt
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