Raw Finance

In combating the global financial crisis, governments have turned to easy monetary policy and large fiscal stimulus programs.  For countries that have run enormous current account surpluses, like China, fiscal stimulus comes easy because they have the money to spend.  However, countries that have run enormous current account deficits, like the United States, will find that, even if their fiscal stimulus works, they will have the separate and unpleasant problem of seeking a way to pay for it later.  In light of this, it is worth considering whether fiscal stimulus programs are the best way to jumpstart a faltering economy.  Harvard Professor of Economics Robert Barro’s research suggests that the expected multiplier effect of fiscal stimulus, that is how many more dollars are created for each dollar of fiscal stimulus spent, may be much lower than government estimates, and therefore, tax cuts would have the greater effect.

Barro and Charles Redlick, in their most recent publication, conclude:

Our bottom line from this research is that a healthy scepticism is warranted when policymakers claim government-spending multipliers in excess of one. Our estimates suggest that the multiplier effect of defence spending falls more in the range of 0.6 to 0.8, and we find it unlikely that non-defence multipliers would be larger. Therefore, our conclusion is that total economic output increases less than one-for-one with increased government purchases. However, we do find evidence to support the view that tax cuts stimulate total output, with a one percentage point decrease in the average marginal tax rate leading to an increase of about 0.6% in the growth rate of real per capita GDP. As such, our preference in the design of fiscal stimulus packages would be for more tax cuts and less reliance on increased government spending.

To view the full column by Barro and Redlick at VOXeu.org, please click the following link:  Design and effectiveness of fiscal stimulus programmes