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Macroeconomic policies will not always stabilize economy by reducing heightened uncertainty, European Central Bank Executive Board Member Lorenzo Bini Smaghi said Wednesday.
"Experience has shown that these policies may well turn out to be destabilizing, especially if they are implemented in a way which increases the state of uncertainty, instead of reducing it," Bini Smaghi said in a speech at the University of Pavia in Italy. "This may happen, in particular, if the size of the fiscal and/or monetary injection is such that irreducible uncertainty is increased, rather than reduced."
He said the need to avoid creating excessive uncertainty about a country's long-term fiscal solvency represents the fundamental limit to the extent of the fiscal stimulus which can be injected into the economy.
The central banker said lack of timeliness is a fundamental problem of fiscal policy. As implementation of fiscal stimulus packages undergo through political processes, it become part of a larger bargaining process between competing interest groups. Hence, not only the timing, but also the extent and composition of the fiscal stimulus become comparatively uncertain.
He noted that monetary policy has limitations when it comes to stabilization purposes as protracted use of low interest rates may fuel new imbalances, particularly asset price bubbles. Further, he said there is a risk that the lessons of the crisis will be quickly forgotten if the analytical framework underlying the policy decisions is not substantially improved.
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