policymakers demonstrate

Fiscal and Monetary Policies after the Crises 411
We are fully aware that many issues raised by the crisis have not, so far, found
a satisfactory answer in theory and policy-making. Yet our focus is on what the
academic literature does provide, rather than what it does not. Even allowing
for this, space constraints have forced us to interpret our remit narrowly, and
two omissions should be singled out upfront. First, while we analyse the consequences
of sovereign risk crises for the design of stabilization policy, we do
not delve into a comprehensive analysis of debt sustainability and issues in debt
default. Second, we do not go in detail on the specific roots of the financial crisis,
although we devote a long section to stabilization policy in the wake of such
acrash.
The chapter is structured as follows. Section 10.2 synthesizes the academic
debate predating the crisis, documenting substantial heterogeneity in views
and theories at odds with popular media accounts. Section 10.3 provides the
macroeconomic context for the crisis and briefly introduces key challenges to
the design of stabilization policy. A long section follows with an account of the
debate on what has caused policy rates to fall to, and be constrained at, their
zero lower bounds, and how to stabilize the economy via forward guidance,
fiscal policy, or central bank purchases of assets. In Section 10.5 we account
for models and mechanisms that have been recently proposed, to account for
large and persistent periods of low economic activity and inflation. Section 10.6
focuses on issues that are specific to the Eurozone, including low risk sharing,
the role of fiscal policy and economic reforms.
10.2 The Pre-Crisis Consensus, and Heterogeneity
Our starting point is the strengthening consensus among policy-makers, up to
the eruption of the global crisis, that the most important questions relating to
macroeconomic stabilization were essentially resolved. Developed economies
were benefitting from the steady, low-inflationary period of growth known
as the ‘Great Moderation’, with improved monetary policy-making widely
believed to have been a contributory factor in engineering this. 1 The launch
of the euro, the greatest monetary experiment in recent history, went far more
smoothly than even optimistic observers were expecting. The newly created
European Central Bank appeared to be able to steer the European economy
in the ‘uncharted waters’ of the newly created economic space defined by the
common currency without substantial problems. Possible issues foreshadowed
by the body of literature loosely referred to as Optimum Currency Area theory
did not seem to materialize. More generally, the ongoing process of rapid
trade and financial globalization, with the growth in supply chain and global and
international banking, did not seem to alter in any substantive way the best practice
of monetary and fiscal stabilization, essentially focused on inward-looking
objectives such as inflation and the output gap at the national level. Of course