Supply and Price Effects of Monetary and Fiscal Policy in Poland under Transition: An Econometric Analysis

From the end of the Second World War until the early 1970s the neo-classical synthesis dominated macroeconomics. This synthesis concluded that changes in the nominal money supply led to changes in aggregate demand, employment and output in the short run because of nominal rigidities in wages and prices, but in the longer-run changes in the money supply led to sustained changes in the price level, rather than in real output. In the early 1970s this synthesis was challenged by, among others, Lucas (1972, 1973), who argued that in a model with perfect competition anticipated monetary shocks would have no effect on output. Although unanticipated monetary shocks would have some impact on output in the short run, this was only possible to the extent that private-sector agents were deceived. An alternative line of research that overturns Lucas’s argument is that based on models of imperfect competition. Fischer (1977) and Taylor (1979) show how with nominal wage and price-setting, nominal money shocks could have long-lasting effects on output and employment. More recently, since the mid-1980s, economists have been seeking the origins of these nominal rigidities. Mankiw (1985) argues that with imperfect competition in response to a change in aggregate demand the private return to each price-setter of adjusting his prices is smaller than the social returns. Thus small menu costs may lead to nominal rigidity and large output effects. Thus, despite changing theoretical fashions, in the presence of nominal rigidities it is widely expected that monetary and fiscal policy can have a sustained effect upon output and employment.