The Limitations of Monetary Policy Essay

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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
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The Congressional Budget Office (CBO) projects that interest payments on US debt will increase from 1.2% of GDP in 2009 to 3.9% in 2020, which could significantly dampen GDP growth. Mankiw projects that the current deficits have already reduced national income by 3 to 6 percent, which could conceivably increase in the years to come.
2. Monetary Policy as a More Effective Lever Thus, critics argue that monetary policy is a more effective tool to fight recessions. Christina and David Romer demonstrated that fiscal policy rarely reacts with the immediacy necessary to enact change during a trough in economic activity. Romer finds that there has been no significance to discretionary fiscal policy during troughs, while monetary policy has a seemingly significant role during historical recessions. John Taylor agrees, stating that even in the face of the lower bound of zero on interest rates, additional measures such as quantitiative easing would prove effective countercyclical policy. Ultimately, both economists reach the conclusion that there is no significance to discretionary fiscal policy during a recession, instead determining that monetary policy is the more effective tool. These critics also point to several other advantages of monetary policy, including the ability to enact policy in small increments, roll back unsuccessful policies, and the short lag time associated with monetary policies.
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