The Trouble With Fiscal Stimulus

There’s been a fair amount of blogospheric bemoaning of the failure of policymakers to adequately embrace the idea of fiscal stimulus as a macroeconomic stabilization policy. And as readers know, I’m very sympathetic to that point of view. But at some point when your side of the argument fails to carry the day, you do need to start thinking about why you’re not persuading people.

And in this case, I think the problem is pretty clear: In the absence of broad political consensus about the appropriate size and scope of the public sector, efforts at fiscal expansion will necessarily get bound up with these debates. For example, many liberals view the idea of a payroll tax holiday with suspicion because they suspect the revenue losses will provide further grist for the argument that Social Security is “bankrupt” and benefits need to be cut. Conversely, conservatives are reluctant to support “temporary” increases in the generosity of social welfare programs out of fear that in the future allowing those increases to expire will be characterized as a “cut.”

Or at the state and local level, anyone who’s thinking seriously about the issue ought to see that the middle of a recession is a terrible time to implement major cutbacks in public spending. But at the same time, people who believe in good faith that state and local spending is above the optimal level will understandably agree with Rahm Emannuel that you don’t want to let a good crisis go to waste. After all, were center-left Keynesian economics bloggers issuing table-thumping condemnations of state and local spending increases in 2004–2007? Bemoaning the fact that we’d entered a new “dark age” of macroeconomic understanding where policymakers didn’t realize that under the circumstances states and municipalities ought to be trimming its workforce and accumulating huge surpluses? I think I missed that.

It seems to me that Germany and Sweden entered the recession with less Keynesian political cultures, but more consensus about the long-term equilibrium level of public spending. And not coincidentally, both of those countries did a much better job of executing the “stimulus in the downturn, then move to consolidation when growth returns” move than America has.


So the practical problem facing proponents of a large fiscal role in stabilization is to come up with ideas that work given this setting. That means, I think, doing something to stop state and local fiscal policy from being pro-cyclical and it means doing something to elaborate rule-based monetary policy measures for when nominal interest rates are close to zero.