Economic policy options in conditions of weak growth and low inflation

Abstract

Five years have now passed since the most acute phase of the financial crisis. Despite substantial monetary and fiscal policy measures to stimulate the economy, the global recovery has been fragile and uneven. During the course of 2013, recovery finally got underway in the euro area, too, and economic activity is slowly reviving. With the weak economic trajectory, inflation has come down to a very low level, and the pace of change in relative prices has faded. Low inflation and the rigidity of relative prices suggest recovery from the financial crisis will continue to be slow. This article examines the economic policy alternatives in conditions of weak growth and low inflation. The sluggish performance of the post-financial-crisis euro area economy in the years 2009-2013 is modelled using a dynamic stochastic general equilibrium (DSGE) model developed at the IMF.1 Understanding the causes of slow growth and weakening inflation will provide a basis for future policy choices. The article also examines structural, fiscal and monetary policy options for boosting the pace of economic growth. Based on our observations, no single policy alternative will on its own suffice to close the output gap. If we really want to accelerate recovery from the financial crisis, all segments of economic policy must be harnessed.