The Limitations of Monetary Policy

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Mr. Emanuel, in the current economic climate, the Obama administration’s course of action has been to pursue aggressive countercyclical fiscal policies designed to prevent further economic deterioration. Critics of these policies argue that: 1. The current fiscal stimulus is ineffective and has done little to create new jobs at a significant cost. 2. Monetary policy is a more effective lever to reduce unemployment and smooth the business cycle, due to its shorter implementation lag and ability to act in small multiples. However, despite these arguments, significant evidence demonstrates the continued need for continued fiscal stimuli, in addition to the monetary policies already undertaken: 3. With interest rates floating near 0% and several extraordinary measures still in place, the Federal Reserve has reached the limitations of monetary policy, necessitating continued fiscal action. 4. The American Recovery and Reinvestment Act has demonstrated success in reducing unemployment, demonstrating the potential for fiscal policy in the current climate. 1. Current Fiscal Stimulus Many economists critical of the Obama administration have argued that sustained deficit spending negatively affects the economy. Prior to the passage of the ARRA, Feldstein stated that “spending should be big, quick, and targeted at increasing aggregate activity and employment.” However, Feldstein later argued that since a large portion of the stimulus package is designed to pay out slowly, it inherently works against the intent of countercyclical policy. John Taylor, creator of the seminal rule of monetary policy, agrees with this assessment, additionally citing the statistical insignificance of the 2001 and 2008 tax rebates at increasing consumer s... ... middle of paper ... ...n inaccessible in the current recession. Additionally, a large fiscal stimulus can reduce loan defaults, increasing liquidity and reducing the need for exceptional lending programs at the Federal Reserve. With the possibility of a double-dip recession still looming, prudent fiscal policy calls for a stimulus that will smooth GDP growth for several years. During a normal recession, critics would be correct in their claims that monetary policy would be ideally suited to smoothing the business cycle. However, due to the financial crisis, many standard monetary tools have been exhausted, necessitating extraordinary fiscal stimuli. The ARRA and other discretionary fiscal measures have been successful in staving off a further reduction in employment and GDP, and the current recession has demonstrated that fiscal policy has been effective at enacting economic recovery.

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