Article | Brookings Papers on Economic Activity | spring 2011

An Exploration of Optimal Stabilization Policy

by N. Gregory Mankiw and Matthew C. Weinzierl

Abstract

This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short-run and flexible in the long-run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions differ significantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used "bang for the buck" calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.

Keywords: Business Cycles; Framework; Theory; Business Model; Markets; Welfare or Wellbeing; Policy; History; Balance and Stability; Business Organization; Price;

Citation:

Mankiw, N. Gregory, and Matthew C. Weinzierl. "An Exploration of Optimal Stabilization Policy." Brookings Papers on Economic Activity (spring 2011). (Also Harvard Business School Working Paper, No. 11-113, May 2011 and NBER Working Paper Series, No. 17029, May 2011.)