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Brooks Wilson's Economics Blog: Fiscal Policy

Thursday, November 19, 2009

Fiscal Policy

I have not taught fiscal policy in my principles classes for some time.  There seemed little need.  My reading of the macroeconomics literature was that the efficacy of fiscal policy was limited to the rare occurrence of a deep and long recession.  Based on the length of the Great Moderation, a period of low inflation, strong economic growth and high employment, I believed that monetary economists working inside the Federal Reserve had learned to better manage the business cycle.

A recession began when the housing bubble burst in 2007, straining our highly leveraged financial sector.  The economy headed south, leaving the desiccated memory of the Great Moderation in the dust, and beginning what many have termed the Great Recession, both long and deep, the conditions required for effective fiscal policy.

Fiscal policy is the sue of the federal government's taxing and spending authority to achieve or maintain full employment or price stability.  In times of recession, the government creates or enlarges deficits to maintain aggregate demand, the total level of demand for all goods and services throughout the economy.  Policy makers can cut taxes, increase spending or some combination of the two to reach desired deficits.  The additional spending by the government or recipients of tax cuts has a multiplied impact through the economy.  For example, Ben gets a $100 tax cut which he uses to buy a new Sony DVD player.  Sony uses the extra money to buy $90 of labor.  The $90 of wages buys $80 of groceries and so on. 

All theories are just good stories until empirically verified.  The focus of the empirical debate has turned on the size of the multipliers.  Multipliers greater than one stimulate growth while those less than one restrain growth.  Robert Barro and Charles Redlick describe the literature on empirically estimated multipliers as "thin" in "Macroeconomic Effects from Government Purchases and Taxes," NBER Working Paper No. 15369.  The authors estimate the multiplier at .7 when the economy is experiencing unemployment of 5.6%.  It increases .1 for every 2% increase in unemployment, implying that stimulus spending becomes beneficial (multiplier greater than 1) when the economy is experiencing 12% or greater unemployment.  In a Wall Street Journal article (Stimulus Spending Doesn't Work) that presents their findings, they conclude,
The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP. 
Barro and Redlick have not given the final word on multipliers but their research is a good starting point for evaluating the effectiveness of fiscal policy and the size of multipliers


  1. Michelle Toups29/11/09 10:38 PM

    Based on the U.S. Bureau of Statistics, the unemployment rate of the United States is 9.5%. Given this information and Barro and Redlick's research, I would conclude that we should lower taxes to get the unemployment rate up rather than trying to use a multiplyer. According to their research, stimulus spending will not raise the GDP by more than the government spending until the unemployment rate is at 12% or greater. Until it is, I assume we should reduce taxes.

  2. Michelle Toups29/11/09 11:49 PM

    enployment* rate up...not unemployment :)
    multiplier* instead of multiplyer...:) :) sorry

  3. LaToya Brinkley30/11/09 4:47 PM

    I believe that lowering taxes is a good option, but I believe that Barro and Redlick are on top of their work. I think that any little bit helps for those that are unemloyed. The unemployed,I believe would rather have a multiplier with money they can see now versus lower taxes which they can't see the money unless they are getting hired.

  4. Kristie DeMaria1/12/09 8:13 PM

    So based off of this research, Obama's talk of trying to lower unemployment by releasing another stimulus bill would not help because our unemployment is not high enough. The interesting thing is that Bush Jr. did give tax breaks in 2001 and the real GDP rose by about 2.4% but unemployment also rose by 2% between 2001-2003. BY 2007 it had dropped back down to 4.5% (as opposed to the 4.2% in 2001). Based off of this former president, giving the people tax cuts did raise the real GDP, but it did not lower unemployment. So then are these the only two options? Both have been tried recently and failed. Do we need to do a combination of the two or are we looking at this problem from the wrong angle?

  5. Laura Ehlers3/12/09 8:46 PM

    Because the United States is part of a global recession, I do not feel that the U.S. can fix the financial problems by ourselves. This could possibly be one reason that the fiscal policies that our country has been trying to enact have not been successful. Our country does not have the power to control all the nations that we do business with. It seems like the middle class tends to get the short end. The U.S. does not need to see another Great Depression. Government does need to be involved to sustain the economy, but I feel that our government is too involved.

  6. Tyler Fadal3/12/09 9:54 PM

    I agree with Laura. Although the ideas behind the fiscal policies sound good, they have obviously not been successful. In my opinion, the government has a role in sustaining our economy, but I believe that our government is too involed in trying to solve our economic problems. The government should regulate the economy as loosely as possible, and let the "invisible hand" control what happens.

  7. A. Katherine Tuel5/12/09 5:20 PM

    So basically we are just trying to find ways to put money in the economy. But one reason that we have this problem is because people are not responsible with their money. Which is the reason the house market went down. I believe that if people receive tax credits from the government, they should be required to take a class about wise money savings or something to this effect. Not all the problem is the government, it is us too!

  8. Janet Frei28/4/10 6:27 AM

    I must admit, stimulus checks are great! They put that extra money in your pocket to do with however you may choose. The problem is that like Katherine Tuel said, "If the people don't know what to do with the money, they should be required to take a class on how to manage their money wisely. I know a lot of people that cannot hold onto a dollar bill to save their life. If you take this type of mindset and place it in a corporation mindset, you end up with CEO's spending the corporations money to fly their mistress to the Bahamas on a 2 week all-expense paid vacation. If money is to be given out, people should be taught how to spend that money to pull their company's out of the mud and put it back where it was when it first became a 5-star corporation.

  9. Patricia Gager28/4/10 12:13 PM

    We received a stimulus check, only to discover when income tax time arrived the small amount received was counted and we ended up paying it back!
    According to, Texas was awarded 11,422,000,000 in stimulus funds. According to the website from Feb 17-December31, 2009, Texas has received 2,745,980,000 of this money for which they have only created 33,542 jobs. The money received and jobs add up to $81,867 per person. How many of these jobs are non-government, permanent, full time jobs? The government is as inefficient and many time more so as regular folks who cannot manage their money. I can see why the stimulus does not raise the GDP. I think tax breaks for things such as appliances, vehicles, and home improvements are better incentitives and contributes more efficiently, because it encourages people to buy things they may not have ordinarily wanted to without the tax break incentitives. Additionally, people don't actually have the money in their hands so it would seem more likely to at least minimize waste, and fraud.

  10. My undestanding is that it all boils down to how much is the multiplier and how high is the unemployment rate. The multiplier, "the amount of money the banking system generates with each dollar of reserves." will only help if the unemployment rate is high like double digits.
    The money that the multiplier will add in the money supply has its limits, it's not infinite.

  11. Danielle Caserta28/4/10 11:02 PM

    so your saying by coming up with different plans to fix the deficit will take away taxes? i believe all of our money ( the economy) went to help other countries needs with their issues therefore leaving us still going deeper into the recession.

  12. William Lee Morrow29/4/10 8:00 PM

    Even during the Great Recession the rate of unemployment only reached a high of 10.6%. But it seems that stimulus spending did help, the current unemployment rate is 10.2%. This may just be a fluke, but since the extra stimulus spending real GDP has recovered along with real GDI. Now the economy has strong upward momentum. Ends of recessions are characterized by a boomerang effect, the harder you fall the faster you bounce back. In order for the boomerang effect to occur though, the economy needs to get out of the rut it is stuck in. America got out of its rut through stimulus spending. The direct amount it contributes to the rise in GDP is not important. All the economy needed was a little push in order for it to begin to bounce back.

  13. Rachel Moore30/4/10 9:32 AM

    I too agree that the government is a little too involved. It's a two way deal. The government can try to figure out many different ways to put money in the economy, but unless the people do their part in regulating the money given to them, the governments work becomes pointless. This problem is not new to the economy, and many bills and laws have been made in effort to effect the unemployment rate positively. However none have made an outstanding impact, maybe Kristie is right, we could be looking at the wrong angle...

  14. Shane Dahya7/11/11 6:52 PM

    Shane Dahya Says: So now I think with this policy that the government are finding all kinds of ways to take money from the people and put it into the economy to make it start going. But isn't most of that the problem cause people don't have money and its going other places, that there not able to contribute to the economy by buying the things they want?

  15. It seems the government is too involved. Has anyone read the book "Atlas Shrugged" by Ayn Rand? The great producers of the era leave the domestic forefront of production and hide out in a remote area in Colorado. Subsequently the government ran society failed. It was rated the second most influential books by the library of congress about a decade ago, it was written in 1939. It states that the less government the better. The reason for this is that the government takes away from capitalism, which is one of the greatest ideals in the history of economics. People think now were in a panic mode flailing economy, when at most unemployment is at 10% today. In the great depression it was near 50%. That helps put things in perspective.