Fiscal stimulus

During the calm period in recent U.S. macroeconomic history, from the mid1980s to mid-2000s, stabilization policy relied mainly on monetary policy to deal with recessions, which were mild and many years apart. Besides relatively small tax rebates, there seemed to be little need for fiscal stimulus. The government did not launch major public works or infrastructure projects to try to restore full employment. Even monetary policy fell short of its full stimulus: the Federal Reserve did not push its target interest rate all the way to zero in either of the recession years 1991 or 2001. It wasn’t until the extraordinary conditions facing the incoming Obama administration in January 2009 that monetary policy was at its maximal stimulus in terms of the traditional tool, the Fed funds interest rate. The bottom had fallen out of the economy in the last months of 2008. The new administration made fiscal stimulus a key part of its program for saving the economy.

Fiscal stimulus has two arms. One is the government’s direct purchase of goods and services. Though the government buys a huge variety of products and employs millions of workers, the focus of stimulus is usually public construction, called “public works” in the past and now known as “infrastructure.” I include all levels of government in infrastructure stimulus because it is common for the federal government to pay for projects that state and local governments build. I will refer to the first arm as infrastructure stimulus, though I will show that the federal government delivered almost no increase in infrastructure spending and that state and local governments cut spending during the recession. A greater effort on the part of the federal government to prevent the decline in state and local purchases would have served the purpose of the stimulus effort.

The second arm of fiscal stimulus pays increased benefits to the public. Expanded unemployment insurance is a leading form, but many other types of public benefits grow during recessions as well. The second arm also includes tax rebates and other tax cuts that put more cash in the hands of the public. I do not include tax cuts in this article, however, because the modest tax rebate in 2008, though a response to the mild contraction that started at the beginning of 2008, was not an important part of the government’s response in 2009 to the Great Recession.

One simple measure of the effectiveness of fiscal stimulus–the multiplier–receives the most attention from economists and often enters public debate as well. The multiplier records the number of dollars of increase in total national output and income per dollar of stimulus spending. Much of this article reviews current thinking among economists about the size of the multiplier. A weak consensus holds that in normal times, including earlier recessions, the infrastructure multiplier is about one: each dollar of infrastructure stimulus boosts output by a dollar. Put differently, when the government buys more highways and schools, output rises by enough to permit other categories of spending– such as consumption and private investment–to remain unchanged. In times of extreme recession, such as 2009, there is widespread agreement that the infrastructure multiplier is higher–perhaps twice its normal value.

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