Which kind of countercyclical fiscal policy is best?

by on November 30, 2016 at 12:19 am in Economics | Permalink

Miguel Faria-e-Castro, on the job market from NYU, has a very interesting paper on that question.  Here are his findings:

What is the impact of an extra dollar of government spending during a financial crisis? How important was fiscal policy during the Great Recession? I develop a macroeconomic model of fiscal policy with a financial sector that allows me to study the effects of fiscal policy tools such as government purchases and transfers, as well as of financial sector interventions such as bank recapitalizations and credit guarantees. Solving the model with nonlinear methods allows me to show how the linkages between household and bank balance sheets generate new channels through which fiscal policy can stimulate the economy, and study the state dependent effects of fiscal policy. I combine the model with data on the fiscal policy response to assess its role during the financial crisis and Great Recession. My main findings are that: (i) the fall in consumption would had been 1/3 worse in the absence of fiscal interventions; (ii) transfers to households and bank recapitalizations yielded the largest fiscal multipliers; and (iii) bank recapitalizations were closest to generating a Pareto improvement.

Bank recapitalizations — just remember that the next time you hear someone talking about “G” in the abstract.

See also this new Alesina NBER paper, indicating that the how of fiscal adjustment is much more important than the when.  No tax hikes!

1 prior_test2 November 30, 2016 at 12:53 am

‘Bank recapitalizations — just remember that the next time you hear someone talking about’ this – ‘The second set of solutions involves taking control of insolvent banks, either by nationalizing them or declaring them bankrupt. In the past, the Federal Deposit Insurance Corporation has used the model of rapidly shuttering failed banks, and it has usually worked.’ http://www.nytimes.com/2009/03/01/business/economy/01view.html?_r=1&scp=4&sq=tyler%20cowen&st=cse

2 Lurker November 30, 2016 at 5:01 am

Based on what I have read here, the best policy is not to have one.

3 rayward November 30, 2016 at 7:54 am

Monetary stimulus and fiscal stimulus are complementary, not simply alternative tools in the tool box to be applied in a crisis. In a financial crisis, fiscal stimulus won’t stop the collapse in (or inflate) asset prices; and in the economic crisis that follows the financial crisis, monetary stimulus won’t induce banks to lend or business and consumers to borrow and spend. The battle lines between supporters of monetary stimulus and supporters of fiscal stimulus are more ideological than practical (or theoretical); and for many Republicans, as we are about to see, political. Of course, that leaves out the Austrians – our friends who dislike everybody (i.e., those who support monetary stimulus and those who support fiscal stimulus).

4 Art Deco November 30, 2016 at 4:04 pm

Most assessments of fiscal stimulus find the multiplier to be weak. Not much point in it in an ordinary recession.

5 Art Deco November 30, 2016 at 8:59 am

How about: maintain real spending on plant, equipment, and transfers per extant projects and priorities (and adjusting to account for currency erosion), pay out unemployment compensation per extant policy, adjust public employee compensation per changes in nominal compensation per worker in the private economy, leave tax rates where they are, and borrow more to make up deficits?

If you’re in an emergency such as was faced in 2008, you can step up replacement purchases (something Martin Feldstein recommended), suspend collection of certain taxes for a quarter, inject capital into troubled financial institutions, &c.

6 Donald Ptretari November 30, 2016 at 3:55 pm

“…you can step up replacement purchases…” Schumpeter had a similar proposal.

7 mkt42 December 1, 2016 at 3:39 pm

It’s a fine idea, but many states have constitutional requirements that they balance their budget each year, so when a recession occurs and tax revenues fall, they are required to either reduce spending or raise tax rates (or create new taxes).

The feds of course are a different matter.

8 Donald Pretari November 30, 2016 at 6:16 pm

Who is advocating a tax increase? The idea is that, as the economy recovers, tax receipts will go up, but that is different than a tax increase. That would be a countercultural policy. Raising taxes going forward qualifies as ad hoc, and not as a particularly countercyclical policy, I think.

9 Peter December 2, 2016 at 9:03 am

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