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  3. American Economic Review
  4. May 2022
  5. Effective Demand Failures and the Limits of Monetary Stabilization Policy

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Effective Demand Failures and the Limits of Monetary Stabilization Policy

  • Michael Woodford
American Economic Review
vol. 112, no. 5, May 2022
(pp. 1475–1521)
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Abstract

The challenge for stabilization policy presented by the COVID-19 pandemic stems above all from disruption of the circular flow of payments, resulting in a failure of what Keynes (1936) calls "effective demand." As a consequence, economic activity in many sectors can be inefficiently low, and interest-rate policy cannot eliminate the distortions—not because of a limit on the extent to which interest rates can be reduced, but because interest-rate reductions fail to stimulate demand of the right sorts. Fiscal transfers are instead well suited to addressing the fundamental problem, and can under certain circumstances achieve a first-best allocation of resources.

Citation

Woodford, Michael. 2022. "Effective Demand Failures and the Limits of Monetary Stabilization Policy." American Economic Review, 112 (5): 1475–1521. DOI: 10.1257/aer.20201529

Additional Materials

JEL Classification

  • E23 Macroeconomics: Production
  • E32 Business Fluctuations; Cycles
  • E43 Interest Rates: Determination, Term Structure, and Effects
  • E52 Monetary Policy
  • E62 Fiscal Policy
  • E63 Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
  • H63 National Debt; Debt Management; Sovereign Debt