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Effective Demand Failures and the Limits of Monetary Stabilization Policy

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  • Michael Woodford

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.

Suggested Citation

  • Michael Woodford, 2020. "Effective Demand Failures and the Limits of Monetary Stabilization Policy," NBER Working Papers 27768, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27768
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    References listed on IDEAS

    as
    1. Saki Bigio & Mengbo Zhang & Eduardo Zilberman, 2020. "Transfers vs Credit Policy: Macroeconomic Policy Trade-offs during Covid-19," NBER Working Papers 27118, National Bureau of Economic Research, Inc.
    2. David Baqaee & Emmanuel Farhi, 2022. "Supply and Demand in Disaggregated Keynesian Economies with an Application to the COVID-19 Crisis," American Economic Review, American Economic Association, vol. 112(5), pages 1397-1436, May.
    3. Oh, Hyunseung & Reis, Ricardo, 2012. "Targeted transfers and the fiscal response to the great recession," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 50-64.
    4. Veronica Guerrieri & Guido Lorenzoni & Ludwig Straub & Iván Werning, 2022. "Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?," American Economic Review, American Economic Association, vol. 112(5), pages 1437-1474, May.
    5. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-388, May.
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    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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