In a New Keynesian model temporarily stuck at the Zero Lower Bound with less than potential output, a “temporary” increase in Government spending will increase output, but a “permanent” increase in G will have no effect. But “temporary” has a very precise meaning here. It does not mean what a normal person might think it means. If people expect any delay, however short, in cutting G after the economy escapes the ZLB and returns to potential output, the increase in G might as well be permanent. It will have no effect on output at the ZLB.
That is from Nick Rowe, who writes a good post on the topic. Nick’s post brings out my inner Arnold Kling, as I think these models are on the wrong track altogether. If you are going to live in these models, however, Nick poses a clincher:
Now ask yourself a second question: which would be easier: getting people to expect there will be zero lag in cutting G; or getting people to expect a permanent increase in M? (Where “permanent” means “lasting longer than the ZLB”.)
This may shock those who inhabit the economics blogosphere, but even in a demand-side model the most important question about fiscal policy is probably how well the money is being spent.