Working Paper: NBER ID: w27768
Authors: 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.
Keywords: Effective Demand; Monetary Policy; Fiscal Policy; COVID-19
JEL Codes: E12; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| COVID-19 pandemic (H12) | effective demand failures (D12) |
| effective demand failures (D12) | lower economic activity (R11) |
| interest rate reductions (E43) | insufficient demand (J23) |
| fiscal transfers (H87) | efficient allocation of resources (D61) |
| effective demand failures (D12) | economic activity being much lower than efficient allocation (D61) |