Effective Demand Failures and the Limits of Monetary Stabilization Policy

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.

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