The modern synthesis view of fiscal policy stresses
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The present paper offers a fundamental critique of fiscal policy as it is understood in theory and exercised in practice. Two specific demand-side stabilization methods are examined here: conventional pump priming and the new designation of fiscal policy effectiveness found in the New Consensus literature. A theoretical critique of their respective transmission mechanisms reveals that they operate in a trickle-down fashion that not only fails to secure and maintain full employment but also contributes to the increasing postwar labor market precariousness and the erosion of income equality. The two conventional demand-side measures are then contrasted with the proposed alternative—a bottom-up approach to fiscal policy based on a reinterpretation of Keynes’s original policy prescriptions for full employment. The paper offers a theoretical, methodological, and policy rationale for government intervention that includes specific direct-employment and investment initiatives, which are inherently different from contemporary hydraulic fine-tuning measures. It outlines the contours of the modern bottom-up approach and concludes with some of its advantages over conventional stabilization methods.
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From a policy perspective, these models lead to a new and better understanding of the costs of economic downturns. For example, consider the latest recession. During the four quarters from June 2008 through June 2009, per capita gross domestic product in the United States fell by roughly 4 percent. In a model with no asset market frictions, all people share this proportionate loss evenly and all lose two weeks’ pay. Such a loss is certainly noticeable. However, I would argue that it is not a huge loss. Put it this way: This scale of loss means everyone in the United States ends up being paid in June 2009 the same (inflation-adjusted) amount that they made in June 2006.