Macroeconomic policy response to pandemic: A paradigm shift in sight?

Abstract

Economic disturbances are always an opportunity to check the validity of an economic theory or paradigm. In the case of the COVID-19 pandemic, an interesting question arises: whether monetary and fiscal policy responses were aligned with a dominant macroeconomic paradigm (New Consensus Macroeconomics) or we are witnessing a paradigm shift to some extent? The analysis in this paper aims to address this question by showing how the abandoning of the sound finance principle due to pandemics opened a room for reaffirmation of the functional finance approach and Modern Monetary Theory. Deficit financing of the aggregate demand was a necessity concerning economic disorder induced by pandemic and the evident inability of monetary policy to address this problem alone due to the liquidity trap. It confirms the rule that, as in all recent economic crises, Keynesian-type economic measures were implemented. Therefore, at least a slight change in the mainstream macroeconomic model regarding the treatment of the fiscal policy and the role of public debt management is suggested. The main conclusion is that the approach to economic policy and the coordination of the monetary and fiscal measures should be upgraded to provide more flexible mechanisms to respond to economic disturbances. Their role would be to ensure a more prompt reaction without previous considerations through the lens of fiscal discipline. Furthermore, the role of fiscal policy should be broadened from traditional public debt management to aggregate demand management, whereas monetary policy could be also used for a temporary reduction of debt burden.