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Will Eurozone Policymakers Take the Long View?

Summary:
The 2010s were an exceptional decade that called for unprecedented economic policies. Now, however, the eurozone's fiscal and monetary policymakers must think more long-term and accept that continued stimulus measures are unlikely to offset the effects of Europe's demographic decline. BRUSSELS – The beginning of a new year, and the start of a new decade, is a good time for longer-term reflection on economic policy. In the 2010s, a decade dominated by the aftermath of a once-in-a-lifetime financial crisis, a strong monetary and fiscal stimulus was clearly justified. In fact, there is now general agreement that large fiscal expansions by governments almost everywhere, followed by unconventional monetary policies, were instrumental

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The 2010s were an exceptional decade that called for unprecedented economic policies. Now, however, the eurozone's fiscal and monetary policymakers must think more long-term and accept that continued stimulus measures are unlikely to offset the effects of Europe's demographic decline.

BRUSSELS – The beginning of a new year, and the start of a new decade, is a good time for longer-term reflection on economic policy. In the 2010s, a decade dominated by the aftermath of a once-in-a-lifetime financial crisis, a strong monetary and fiscal stimulus was clearly justified. In fact, there is now general agreement that large fiscal expansions by governments almost everywhere, followed by unconventional monetary policies, were instrumental in preventing the Great Recession from turning into a repeat of the Great Depression of the 1930s.

But now that the crisis has been overcome, the question for eurozone policymakers in particular is whether to continue with emergency measures into the 2020s, and, if so, what long-run effects one should expect. And that is where we quickly bump up against the limits of economic knowledge.

Both economic theory and much evidence suggest that a fiscal stimulus will lead to more demand and employment in the short run, especially when financial markets are in disarray.

But economists fundamentally disagree as to the longer-term effects of fiscal policy when markets are working normally. Although theory suggests that expansionary fiscal policy can induce a forward shift in household expenditure, in the long run, consumers will spend only what they earn. Moreover, the long-term empirical evidence is thin, because few countries have run persistently large fiscal deficits or surpluses over decades.

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