INTRODUCTION TO THE SPECIAL ISSUE ON ‘FISCAL POLICY’ Andrew Hughes Hallett and Campbell Leith Macroeconomics has the reputation of being a subject plagued by ideological disputes. But a number of authors are now arguing that the field is developing a new consensus: see, for example, Woodford (2003) and Goodfriend and King (1997). These authors have gone so far as to dub this emerging view ‘The New Neo-Classical Synthesis’ (NNCS). Essentially the NNCS extends the optimising behaviour underlying the Real-Business Cycle literature to include the frictions considered by New Keynesian Economists in the 1980s (see Mankiw and Romer, 1991 for a collection of influential papers on this theme). As a result the NNCS can use the insights of Real-Business Cycle theory to explain equilibrium output; while, at the same time, explaining deviations of actual output from equilibrium as a result of stickiness in the adjustment of prices and wages. The NNCS paradigm has been employed in numerous academic studies of monetary policy: see, for example, Rotemberg and Woodford (1997), Clarida et al. (1999), Taylor (1999), and Erceg et al. (2000). Moreover the NNCS has come to dominate policy evaluation in central banks throughout the world (see Taylor, 1999). Despite the success of this research programme in capturing the key features of the monetary policy transmission mechanism, and in defining micro-founded objective functions for policy-makers or describing optimal monetary policy in various policy settings, fiscal policy has typically been ignored in such analyses. To the extent that it is mentioned explicitly, it is typically only as a simplifying device. For example, the fiscal authorities will often be assumed to have access to a lump-sum tax which they use to ensure fiscal solvency such that the equilibria described under the fiscal theory of the price level (FTPL) do not apply. This lump-sum tax will also often be used to finance a production subsidy which eliminates the distortions because of imperfect competition as this removes the Barro-Gordon inflationary bias from the monetary policy problem and makes the derivation of second-order approximations to welfare more straightforward (Woodford, 2003). But fiscal policy does not have a role or purpose of its own. The papers in this special issue are designed to challenge that view. While they are sympathetic to the approach to monetary policy represented by the NNCS, they relax the simplifying assumptions that have enabled that literature to ignore fiscal policy. That is not entirely new of course. A recent series of papers has developed the FTPL (see Woodford, 2001 for a statement of the theory and details of related papers) which questioned the assumption, implicit in most monetary policy models, that monetary policy in isolation can determine prices and inflation. Instead, it was argued that, under certain conditions, prices could be determined entirely by the needs of fiscal solvency rather than the Scottish Journal of Political Economy, Vol. 53, No. 1, February 2006 r Scottish Economic Society 2006, Published by Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA 1