Third-best macro policy

Paul Krugman

Nov. 2009

World industrial production

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1940 1950 1960 1970 1980 1990 2000 2010 2020

Long-term unemployment as % of labor force

Thinking about policy: minimal NK framework

where C is private consumption, G gov’t purchases.

“Fudge factor” to get shock to aggregate demand.

Sticky prices (one period) to get output fluctuations

C+G

Nominal interest rate

Fullemployment

AD

Target rate

The normal case

C+G

Nominal interest rate

Fullemployment

AD

Target rate

The current situation

0

What to do?

First best: Inflation targeting to reduce the real interest rate

Problem: Persuasion/credibility

Second best: Strong fiscal expansion/quantitative easing

Problem: Deficit/inflation fears

Third best: Job promotion/work sharing

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20.0

40.0

60.0

80.0

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140.0

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Net debt as % of GDP

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