Wall Street Journal
March 17, 2011
Government spending to offset a fall-off in demand should be used as a last resort in an economic crisis, in conjunction with cutting taxes and only after all other options are exhausted, a new paper by two Harvard University economists released Thursday said.
Gregory Mankiw, a former chairman of President George W. Bush‘s Council of Economic Advisors, and Matthew Weinzierl implicitly argue against the sequence of tools used by the U.S. to handle the recent crisis, proposing instead a different hierarchy of policies.
The first level, they said, is conventional monetary policy, when the central bank cuts short-term interest rates. The second is a cut in long-term interest rates, and possibly an increase in long-term monetary-policy targets, such as a higher level of gross domestic product. Rather than cuts in taxes and an increase in government spending to prop up demand, the third level should be fiscal policy aimed at encouraging investment. “In essence, optimal fiscal policy tries to do what monetary policy would if it could,” they said.
If those tools aren’t enough to restore employment to healthy levels, “conventional fiscal policy is the demand-management tool of last resort,” they said in a paper presented at the Brookings Institution‘s Papers on Economic Activity conference.
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