Re-examining Monetary and Fiscal Policy for the 21st Century.

Author:Libanio, Gilberto
Position:Book Review

Re-examining Monetary and Fiscal Policy for the 21st Century, by Phillip Arestis and Malcolm Sawyer. Cheltenham, U.K., and Northampton, Mass.: Edward Elgar. 2004. Cloth, ISBN 1843765837, $95.00. 210 pages.

J. M. Keynes once stated that one of his main tasks was to convince his readers that what seems to be sensible is sensible and what seems to be nonsense is nonsense. Phillip Arestis and Malcolm Sawyer appear to face a similar challenge in their Re-examining Monetary and Fiscal Policy for the 21st Century. The book intends to present, discuss, and criticize the so-called "new consensus" in macroeconomics and some of its main policy implications. The authors do so by using simple and sensible arguments, although they often confront some of the current dogmas of the economics profession.

Arestis and Sawyer describe the "new consensus" in macroeconomics (henceforth NCM) by using a simple three-equation model. The first equation represents aggregate demand, with the current output gap determined by the past and expected future output gap and the real rate of interest. The second equation is a Phillips curve, with inflation rates being determined by the current output gap and past and future inflation. The third equation is a monetary policy rule, with a nominal interest rate based on expected inflation, output gap, deviation of inflation from target, and the "equilibrium" real rate of interest (akin to Knut Wicksell's "natural rate").

The model of the NCM outlined in these three equations has a number of features (see chapter 2 of the book). First, it sees expenditure decisions as the result of intertemporal optimization of a utility function. Second, it allows for sticky prices in the short run and full price flexibility in the long run. Also, it assumes long-run money neutrality, with inflation fully determined by monetary policy and equilibrium values of real variables independent of the supply of money. A related feature is that the stock of money is merely a "residual" and has no role to play in the model. Finally, the equilibrium level of unemployment is determined on the supply side ("natural rate" of unemployment, or NAIRU), and the influence of aggregate demand in the long-run path of the economy is ignored or assumed away. In chapter 3, Arestis and Sawyer illustrate the NCM by reference to the macroeconometric model used by the Bank of England in the period 1998-2002.

A great deal of attention is given to the macroeconomic policy...

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