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Macroeconomic policy in wartime is concerned with reducing human suffering, particularly in poor countries where a large proportion of the population is near or below the poverty line. This chapter examines a ‘conflict economy’, which distinguishes ‘war shocks’ from other shocks familiar from modern development macroeconomics, and outlines the main fiscal and external-sector disequilibria that tend to emerge in wartime. It turns to the way in which civil society, firms, and households respond to the shocks and uncertainties of war, and what the consequences are for the macroeconomic behaviour. In addition, the chapter discusses macroeconomic policy in low-income countries affected by armed conflict. It sets out the basis for an alternative approach to macroeconomic stabilisation, which takes into account explicitly the disequilibrium nature of the low-income economy in conflict.

In developing countries, the issue of macroeconomic stabilization has generated a considerable theoretical and political controversy. The chapter presents the theory behind the standard monetary models of stabilization in a closed and open economy that inspires adjustment programmes supported by the IMF, the concrete measures adopted as part of this stabilization approach, and their pitfalls. Mention is also made of the criticism attracted by the approach. The final section analyses the relation between orthodox stabilization and poverty incidence and the trade-off between rapid, front-loaded stabilization, and poverty incidence, as well as a series of measures to reduce the impact of orthodox stabilization on the poor.

The aim of macroeconomic stabilization is restoring price stability and reducing monetary, fiscal, and balance-of-payment imbalances. Macroeconomic stabilization is particularly needed when a country suffers from high inflation or hyperinflation. To stop such an inflation one can choose between three types of anti-inflationary programmes: orthodox money-based, orthodox exchange rate-based, and heterodox. Other cases of macrostabilization policy include reducing excessive fiscal deficit and public debt before they become monetized, dealing with the deflationary consequences of the systemic banking crisis, reducing the excessive current account deficit, dealing with the consequences of a sudden stop in capital flows, and fighting chronic moderate inflation. Fiscal rules, and the independence of monetary and fiscal institutions such as central banks, play an important role in preventing macroeconomic instability. National macroeconomic policies are also monitored from outside, for example by the International Monetary Fund and European Commission (in the case of EU member states).

In contrast to the United States or other federations, the euro area does not have a meaningful federal budget. The budget of the European Union amounts to only one percent of its GDP, lacks flexibility, and plays no role in macroeconomic stabilization. Indeed, in the Maastricht Treaty, all responsibility for macroeconomic stabilization was assigned to national budgets. But when bad times came, the buffer proved perilously small; it may prove even smaller in the future, now that investors pay more attention to state solvency. Stabilisation concerns and financial-stability concerns, therefore, suggest that the repair agenda should not stop with banking union. To create a stabilisation capacity in the euro area, a first solution would be to revisit the MacDougall proposal and equip the monetary union with a true budget. An alternative would be to mimic the operation of a budget, with a purely macroeconomic automatic stabilisation scheme. A last solution would be to make states able to borrow even in situations of stress, in other words letting states issue limited amounts of Eurobonds. European leaders already played with the idea of equipping the euro with a fiscal capacity at the end of 2012, but the idea was forgotten before having been seriously discussed. The issue, however, has not gone away and European leaders would be well-advised to explore the options as the current fiscal regime remains several incomplete.

This chapter shows that euro membership would eliminate shocks to the uncovered interest rate parity condition, which is identified as a major source of exchange rate variation. It considers euro area membership as a U.K. monetary policy option by studying the effect of monetary union under various parameterizations of the Erceg, Gust, and López-Salido model. One issue in determining whether monetary union contributes to an improvement in U.K. macroeconomic stabilization is the status of the uncovered interest rate parity (UIP), or foreign exchange risk premium, shock. The results suggest that monetary union may increase inflation variability if UIP shocks do not disappear at the inception of monetary union. This effect is detectable even though UIP shocks are actually only a modest inherent source of exchange rate variation. This chapter also affirms that if the differences in the degree of nominal wage rigidity across the U.K. and the euro area are sufficiently large, U.K. inflation variability under monetary union is higher than that achievable under monetary policy autonomy. The improvement in U.K. economic stability under monetary union also diminishes if imports from the euro area are modeled as primarily intermediates instead of finished goods.

This introductory chapter describes the changing fortunes of currency board arrangements (CBAs) since their beginnings in colonial times. CBAs were once one of the dominant regimes in small open dependent territories, but were soon abandoned as territories gained independence. CBAs made a comeback in the 1990s as the cornerstone of various macroeconomic stabilization programs. By the late 1990s, countries with CBAs included Bosnia and Herzegovina, Bulgaria, Estonia, and Lithuania. The chapter also considers the debates surrounding the impact of CBAs on inflation.

This chapter employs both theoretical and empirical tools to examine Japanese macroeconomic stabilization over the past five years. The role of fiscal policy in a liquidity trap is reviewed. It is shown that market participants expected that the Bank of Japan (BOJ) would not adopt expansionary monetary policy sufficient to offset an expected decline in the natural rate of interest. The Japanese government has been diverging from Ricardian fiscal policy since the latter half of the 1990s. The optimal commitment solution can be enforced through history-dependent inflation targeting in which the target inflation rate is revised depending on the past performance of monetary policy. The commitment of BOJ failed to have a sufficient impact on the market's expectations about the future course of monetary policy. Moreover, it is noted that the primary surplus in 1999–2002 was higher than predicted by the historical regularity.

This chapter examines the cyclical behaviour of country-level macro-financial variables under EMU Monetary union strengthened the covariation pattern between the output cycle and the financial cycle, while macro-financial policies at national and area-wide levels were insufficiently counter-cyclical during the 2003‑7 boom period. The policy reform agenda required to improve macro-financial stability is examined critically.

The controversies over European social model institutions converge in the basic issue of whether there is necessarily a trade-off between higher employment and lower inequality. The cases and broader studies suggest that the answer is no, and that the employment effects of counteracting markets’ tendency to generate inequality depend on how it is done. But employment also depends on whether macroeconomic policy assures the conditions for it by counteracting markets’ tendency to generate macroeconomic instability. Policy massively failed to do so not only in the interwar Great Depression, but also in the Great Recession in America and especially Europe, where the gaps in the Eurozone’s economic governance institutions left it without the instruments to cope with the crisis. The chapter thus concludes that those institutions’ consequences for employment vastly outweigh any employment effects social models may have, however much variations among them may have aggravated or ameliorated the employment impact of the crisis, whose sources lie elsewhere.