Can aggregate demand be boosted in the euro area and how ?

Jean-Paul Fitoussi

Working Papers from HAL

Abstract: The large (and increasing) output gap that characterizes the euro area suggests that aggregate demand can physically be boosted. Only fiscal policy could fulfil this task though, being monetary policy at the limit, and structural reforms linked to long term growth. The usual arguments against the use of discretionary fiscal policy do not seem to apply in this moment: it is unlikely that in a situation of excess saving and low inflation, government borrowing would cause interest rates to growth hampering medium term growth. On the contrary, fiscal policy has a crucial role in facilitating coordination of the private sector on a high growth equilibrium; a role that now it is not fulfilling. Though potentially beneficial for sustaining aggregate demand and facilitating the recovery, fiscal policy is constrained by the Stability pact. If governments want to act, they should hence temporarily and conditionally suspend the pact, even if coordination of policies should be maintained. If discretionary fiscal policy could be implemented, the most effective measures for short term effects would be temporary tax cuts, infrastructure investment in projects readily implemented, and an increase of expenditure on social capital (health, dependency, higher education, urban renovation, R&D).

Date: 2003-08-29
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Published in 2003

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