This is not the document you are looking for? Use the search form below to find more!

Report home > World & Business

Pros and Cons of various fiscal measures to stimulate the economy

5.00 (1 votes)
Document Description
We review the theoretical and empirical literature on the effects of discretionary fiscal policies, against the background of renewed fiscal policy activism. In this sense, we analyze the main pros and cons of various fiscal tools to stimulate the economy. We show that it is extremely difficult to elaborate an unambiguous catalogue of measures defining an "optimal" fiscal package. Among the requirements that fiscal measures should be "timely, targeted and temporary" (TTT), the implementation of the first one - timeliness - is the least controversial criterion in the current situation. On the basis of the literature review, we provide some hints on the appropriate composition of a fiscal stimulus packages. The review of the pros and cons of short-term fiscal stimulus packages cannot be decoupled from the discussion of the "exit strategies", i.e. the means of financing fiscal expansions, and the intertemporal consistency of fiscal plans.
File Details
  • Added: May, 17th 2010
  • Reads: 1802
  • Downloads: 110
  • File size: 203.34kb
  • Pages: 36
  • Tags: pros and cons, various fiscal measures, the economy
  • content preview
Submitter
  • Username: samanta
  • Name: samanta
  • Documents: 1258
Embed Code:

Add New Comment




Related Documents

Pros and Cons of Drug Testing

by: alfredowpjr, 2 pages

The world of drug testing, full of new information and unfamiliar terminology, can seem overwhelming at first, especially if you are a concerned parent or employer. That’s why TestCountry is ...

Pros and Cons of Pro flight simulator

by: praveenben, 4 pages

Pro flight Simulator is an alternative to professional flight simulators and it is a must game for those who aspiring for pilot training. This is a fully functioning flight simulator

Shopping Cart Types. Pros and Cons

by: james212, 17 pages

Shopping Cart comparison: pros and cons of the most popular shopping cart. See advantages and disadvantages and choose the most suitable shopping cart for you. Use Cart2Cart to migrate you store to ...

Pros & cons of technology

by: claraanderson, 2 pages

DODAggregator software, a hosted daily deal aggregate platform. The software, which will be launched from DODAggregator, is a daily deal aggregate platform designed to let individuals create their ...

Reverse Mortgage Pros and Cons

by: robertporath, 1 pages

As long as the owner resides in the property, pays insurance and property taxes, and maintains the estate as required, the homeowners won’t have to pay monthly mortgage. As a matter of fact, ...

Pros And Cons Of Using Real Wood Flooring

by: olincep202, 2 pages

Pros and Cons of using Real Wood Flooring Due to the wide selection of flooring materials in the market today, choosing the perfect flooring material for your home or office need not be ...

BARACK OBAMA'S PLAN TO STIMULATE THE ECONOMY

by: rika, 3 pages

BARACK OBAMA’S PLAN TO STIMULATE THE ECONOMY Barack Obama’s economic plan will inject $75 billion of stimulus into the economy by getting money in the form of tax cuts and ...

Several Pros and cons for outsourcing techniques online marketing

by: AllanRana, 2 pages

It is sometimes complicated running a small business nowadays. To start with, the particular technology has grow to be significantly innovative and you'll must ensure you could overcome the actual ...

Pros And Cons For Distance Learning

by: wblteam, 1 pages

You will find several benefits of taking distance education online education classes. However, this type of education isn't suitable for everybody. Below you'll find a listing of a number of the pros ...

Pros and Cons of Canvas tarps

by: mytarp.com, 2 pages

Unlike the popular, economical blue tarps designed for short term use, or the heavy duty, 18-ounce vinyl coated polyester lumber tarps, canvas tarps are made from 100% cotton fibers, making them a ...

Content Preview
CAHIER D’ÉTUDES
WORKING PAPER
N° 40
PROS AND CONS Of vARIOUS fISCAl mEASURES
TO STImUlATE THE ECONOmy

Carine Bouthevillain
John Caruana

Cristina Checherita
Jorge Cunha

Esther Gordo
Stephan Haroutunian

Geert Langenus
Amela Hubic

Bernhard Manzke
Javier J. Pérez

Pietro Tommasino
SEPTEMBEr 2009


Pros and Cons of various fiscal measures
to stimulate the economy
Carine Bouthevillain
John Caruana
Cristina Checherita

Banque de France
Central Bank of Malta
European Central Bank

Jorge Cunha
Esther Gordo
Stephan Haroutunian

Banco de Portugal
Banco de España
Central Bank of Cyprus

Geert Langenus
Amela Hubic†
Bernhard Manzke

Bank of Belgium
Banque centrale du Luxembourg Deutsche Bundesbank

Javier J. Pérez
Pietro Tommasino

Banco de España
Banca d’Italia
Abstract
We review the theoretical and empirical literature on the effects of discretionary fiscal poli-
cies, against the background of renewed fiscal policy activism. In this sense, we analyze
the main pros and cons of various fiscal tools to stimulate the economy. We show that
it is extremely difficult to elaborate an unambiguous catalogue of measures defining an
“optimal” fiscal package. Among the requirements that fiscal measures should be “timely,
targeted and temporary” (TTT), the implementation of the first one – timeliness – is the
least controversial criterion in the current situation. On the basis of the literature review,
we provide some hints on the appropriate composition of a fiscal stimulus packages. The
review of the pros and cons of short-term fiscal stimulus packages cannot be decoupled
from the discussion of the “exit strategies”, i.e. the means of financing fiscal expansions,
and the intertemporal consistency of fiscal plans.
(*) Acknowledgements: The authors would like to thank the participants at the ESCB Working Group on Public
Finance meeting of 3-4 March 2009, Frankfurt am Main, Germany. In particular, we would like to thank Karsten
Wendorff, Ad van Riet and Richard Morris for their comments on previous drafts of this paper.
(**) The views expressed in the paper are those of the authors and do not necessarily represent the views of the
ECB or the NCBs involved.

e-mail: amela.hubic@bcl.lu
1

Résumé non-technique
Les responsables de la zone euro et du reste du monde sont intervenus avec promp-
titude ces derniers mois afin d’atténuer les répercussions économiques et sociales
de la présente crise et pour mieux asseoir les perspectives de reprise. Ils ont pour ce
faire fait appel à différents outils (conventionnels et non conventionnels) de politi-
que monétaire et budgétaire.
L’article faisant l’objet du présent résumé passe en revue la littérature théorique et
empirique relative aux effets des politiques budgétaires discrétionnaires, le principal
objectif étant de distinguer les avantages et les inconvénients inhérents à une stimu-
lation de l’économie par le biais de la politique budgétaire. Cet examen montre qu’il
est difficile d’élaborer un catalogue complet et précis des éléments constitutifs d’un
paquet fiscal ”optimal”.
Les mesures fiscales devraient en tout état de cause respecter les trois T: elles de-
vraient en effet être “timely, targeted and temporary”. En d’autres mots, les mesures
devraient être “prise à temps, ciblées et temporaires”. C’est l’implémentation du
premier T (prises à temps) qui est la moins sujette à controverses. En ce qui concerne
la durée de ces mesures, il existe de forts arguments en faveur de mesures tempo-
raires ou, à l’inverse, de mesures plus persistantes. La pertinence respective de ces
arguments antagonistes dépend: (i) de la proportion des agents économiques ayant
des contraintes de liquidité; (ii) de la réaction des taux d’intérêt à long terme et (iii)
de la durée estimée des chocs négatifs touchant l’économie. Par ailleurs, des mesures
ciblant des agents bien spécifiques pourraient s’avérer difficiles à mettre en œuvre,
en raison de l’incertitude élevée entourant les multiplicateurs fiscaux et à cause des
multiples difficultés que comporte l’élaboration d’un paquet fiscal optimal.
Au-delà du débat sur les trois T, la littérature économique suggère que la structure
d’un stimulus budgétaire devrait également prendre en considération des facteurs
tels que: (i) un équilibre approprié entre les effets positifs de court terme (principa-
lement du côté de la demande) et les coûts éventuellement générés par ces mesures
(ces coûts se matérialisent principalement sur un horizon de long terme du côté
de l’offre, mais également de court terme via les marchés financiers); (ii) la taille
attendue des multiplicateurs fiscaux des différents outils disponibles; (iii) le degré
d’ouverture de l’économie; (iv) la nécessité de réduire les distorsions affectant les
mécanismes de marché.
De plus, les résultats des études empiriques montrent qu’à court terme, les multipli-
cateurs de dépenses (spending multipliers) sont plus élevés que les multiplicateurs de
taxation (tax multipliers).
Mis à part les facteurs généraux, les caractéristiques propres de chaque pays sont
d’une importance majeure pour estimer le degré d’efficacité des mesures de stimu-
lus fiscal. Alors qu’un paquet fiscal donné pourrait être jugé approprié pour un pays
touché par un sévère choc de demande, caractérisé par un ratio de dette peu élevé et
par un excédent du budget structurel, ce même paquet pourrait facilement induire
une hausse des primes de risque (taux de financement plus élevés) ainsi que d’autres
effets macro-économiques néfastes dans le cas d’un pays présentant une position
2

de départ défavorable. À cet égard, la stratégie budgétaire de sortie de la crise est
cruciale. Une stratégie encadrée par des règles budgétaires précises et qui ne com-
promet pas la viabilité à long terme des finances publiques – les mesures budgétaires
expansionnistes étant intégrées dans un cadre de consolidation crédible à moyen
terme - a moins de chances d’induire des effets secondaires défavorables qu’une
stratégie impliquant un déficit permanent et non compensé, et ce en violation des
règles budgétaires.
Dans une perspective européenne, le manque de respect par l’un des Etats membres
du cadre multilatéral européen de surveillance budgétaire est de nature à induire
des effets néfastes dans l’ensemble des autres Etats membres, car la crédibilité du
cadre de surveillance précité est négativement affectée par le comportement de l’Etat
“deviant”.
3

Contents
1 Introduction
5
2 The effectiveness of fiscal packages: short-run benefits and potential costs
7
2.1 Short-run benefits on aggregate output
7
2.2 Long-run costs, short-run costs and other considerations
9
3 The effectiveness of fiscal packages and their design
12
3.1 Targeted, timely and temporary?
12
3.2 Coordination vs. country actions
13
3.3 The effectiveness of fiscal packages: what do we know about tax and
spending multipliers?
13
3.4 Government spending multipliers vs. tax multipliers
14
3.5 Beyond aggregate “government spending or tax shocks”
14
3.6 Other issues: fiscal multipliers in high debt countries, and in good and
bad times
15
4 Evaluation of specific fiscal measures to stimulate the economy
16
4.1 Criteria for evaluating different fiscal policy measures
16
4.2 Evaluation of main fiscal measures implemented in the current con-
text
16
5 Conclusions
20
4

1 Introduction
Policy makers in the euro area and worldwide have intervened substantially to
mitigate the economic and social disruptions of the present crisis and to stimulate
recovery through various (conventional or unconventional) tools of monetary and
fiscal policy.
As regards fiscal policy, there is certainly a strong consensus that government
rescue plans for the banking sector were needed to avoid a systemic crisis and
restore confidence. A wealth of studies by the EC, IMF, OECD and also national
bodies have supported this line of action, also in view of the experience of past
banking crises, most notably in Japan, Korea and the Nordic countries.
At the same time, fiscal measures to stimulate the economy in the short run have
been advocated by several voices within the economic profession, including in-
ternational organizations and certain governments, and implemented in many
countries of the euro area and worldwide. On this front, though, the whatever-it-
takes approach that might be valid for financial rescue plans is usually not fully
applicable for demand-oriented discretionary fiscal policy actions.1
First, the need for discretionary fiscal policy measures has to be assessed in conjunc-
tion with the counter-cyclical stimulus of fiscal policy built into tax and spending
systems, i.e. automatic stabilization. Automatic stabilizers are those elements of
fiscal policy that operate without any explicit government action, and thus are
not affected by the implementation lags of discretionary policy. In this regard, a
direct comparison of the “appropriate” discretionary stimulus in the EU and the
US would be difficult, given the larger size of public sectors in the EU, with more
progressive tax systems and more responsive social expenditure (in particular un-
employment benefits).
Second, the affordability of a fiscal stimulus plan depends primarily on an econ-
omy’s existing fiscal conditions or the degree of fiscal stress, either proxied by
a high existing level of government debt, a rapid debt increase, or the extent of
other long-term risks (such as aging costs). It is also likely to depend on the size of
its external imbalances, particularly in the case of emerging economies. Hence, a
country with a high level of foreign debt and / or confronting balance of payments
problems is likely to have less room for fiscal expansion.
Third, even in the event that indeed discretionary packages were to be imple-
mented, some questions remain open to debate: How should they be designed to
maximize the impact on the economy (fiscal multipliers)? How should measures
be tailored, communicated and implemented in order to bolster consumers’ and
firms’ confidence and help reduce aggregate uncertainty in the economy? In the
event of the crisis lasting longer than envisaged, some additional questions could
be posed: Would fiscal measures increase the probability of ending a recession in
addition to mitigating the slump? Would they instead delay the recovery?
1
See European Central Bank (2009), Freedman et al. (2009), Barrell et al. (2009), OECD (2009), Elmendorf and
Furman (2008), or Spilimbergo et al. (2008).
5

This paper reviews the main pros and cons of discretionary fiscal packages trying
to unveil what we can learn from the existing theoretical and empirical literature
on the effects of discretionary fiscal policies, while at the same time drawing
lessons for the actual packages recently put forward in some EU countries. The
paper shows that it is extremely difficult to elaborate an unambiguous catalogue
of measures defining an “optimal” fiscal package, though much attention has
been paid in the policy debate to the requirement that measures taken should be
timely, targeted and temporary” (TTT). As regards the duration of measures,
both temporary and more persistent measures may be defended depending on
the proportion of liquidity-constrained agents in the economy, the reaction of
long-term interest rates, and the expected duration of the adverse shocks hit-
ting the economy. Targeting measures to some specific agents may be difficult in
practice, given the uncertainty surrounding fiscal multipliers and the difficulties
of designing well-targeted fiscal stimulus packages. Timeliness is the least con-
troversial criterion in the current situation.
Beyond the discussion on TTT, the literature suggests that the structure of a fis-
cal stimulus plan should take into account several factors, such as: (i) a proper
balance between the expected short-term positive effects (mainly demand-side)
with the costs that might be expected from the measures (mainly linked to the
longer-term, and the supply side, but also to the short term via financial mar-
kets); (ii) the expected size of fiscal multipliers of various tools available; (iii) the
degree of openness of the economy; (iv) the need to minimise distortions in mar-
ket mechanisms and, in the case of EU countries, the compliance with single
market rules.
6

2 The effectiveness of fiscal packages:
short-run benefits and potential costs
2.1 Short-run benefits on aggregate output
Discretionary fiscal policy measures are usually advocated based on the claim that there
are short-run benefits in the event of a crisis / recession situation. Indeed, several recent
studies seem to provide evidence that additional government spending and / or tax cuts
have a positive effect on aggregate output in the short-term in such a situation. What
remains to be determined is the size of the fiscal multipliers, and the sign and size of the
disaggregated impact on private consumption and private investment.
Private consumption, the biggest component of aggregate demand, has received
most of the attention. The current consensus holds that private consumption will
increase after a positive government spending shock or after temporary tax cuts
due to the increase in disposable income.2
The most popular argument usually advocated is that the consumption of liquid-
ity-constrained or myopic agents reacts strongly to tax reductions or government
spending increases. For example, Gali et al. (2007) find that, conditional on having a
large enough fraction of rule-of-thumb consumers3 (in their benchmark solutions 50%
of the population), and a high degree of price stickiness (average duration of about
four quarters), a government spending shock in the US generates an increase in ag-
gregate consumption even if the latter is not very persistent. Otherwise, the negative
wealth effect of the expected higher taxation would offset the expansionary impact,
a standard result in models without liquidity constraints or price and wage sticki-
ness.4 Inverting the previous argument on the fraction of constrained / unconstrained
agents in the economy, several studies that analyse the non-Keynesian effects of fis-
cal policies claim that fiscal consolidations might have expansionary effects on the
economy if the fraction of unconstrained agents is high enough.5, 6
2
See, for example, Gali et al. (2007), Blanchard and Perotti (2002), Fatas and Mihov (2001), Perotti (2005, 2007),
Mountford and Uhlig (2002), Caldara and Kamps (2008) or Afonso and Sousa (2009). At the same time, some
papers suggest the consumption response to temporary tax cuts may be modest. In this respect, see Shapiro
and Slemrod (1995, 2001), Parker (1999) and Souleles (1999, 2002). Finally, the findings that government spend-
ing shocks cause private consumption to rise is not unchallenged, e.g. Ramey and Shapiro (1998), Edelberg et
al. (1999), Burnside et al. (2004), or Ramey (2008). See Perotti (2007) for a critical discussion of this latter strand
of the literature. Most of the papers referred to in this footnote analyze the US case.
3
By rule-of-thumb (or liquidity constrained or hand-to-mouth) consumers the literature refers to individuals that
do not have access to financial markets, and thus consume all of their current disposable income each period.
4
Standard “neoclassical” models predict that an exogenous increase in government spending will decrease pri-
vate lifetime wealth (given that agents anticipate that increases in spending today will have to be financed in
the future), hence normal goods consumption and leisure declines (hours worked will increase to compensate
for the negative wealth effect caused). The seminal paper most quoted in this respect is Barro (1974). See also
Baxter and King (1993). For recent examples of simulation models that incorporate this theoretical structure in
an otherwise standard “neo-Keynesian” framework see Coenen and Straub (2005) or Coenen et al. (2007).
5
On the assumption of credit market imperfections and the link to constrained and unconstrained individuals, see
Attanasio (1999), Perotti (1999), Giavazzi and Pagano (1990, 1996) or Giavazzi, Jappeli and Pagano (2000). Also on
the issue of the “non-Keynesian” effects of fiscal policies see Schclarek (2007) and the references quoted therein.
6
Monacelli and Perotti (2008) exploit an alternative channel. They set up a standard business cycle model,
except for the presence of price rigidity, and find a positive response of private consumption to a government
spending shock for preferences consistent with an arbitrarily small positive wealth effect on labour supply,
that counterbalances the standard wealth effect. This effect is linked to the degree of complementarity between
consumption and hours. See also Ravn, Schmitt-Grohé and Uríbe (2006).
7

Tagkalakis (2008) analyses the link between the fraction of constrained /uncon-
strained agents and the state of the economy. He develops a model to illustrate
that the fraction of credit-constrained consumers is likely to increase in bad times,
and hence a fiscal expansion is more likely to have a positive and stronger effect on
consumption in economic downturns. This hypothesis is validated in a panel data
set of OECD countries for the period 1970-2002.7
An alternative argument in the literature that rationalizes why private consump-
tion might react positively to an increase in government consumption is based on
the assumption that public and private consumption are complements or, similarly,
that they are imperfect substitutes with sufficiently low elasticity of substitution.
In both cases the rise in government consumption increases the marginal utility of
private consumption so that the negative wealth effect on consumption is counter-
acted.8 Examples of public spending which substitutes private spending include
defence, public order and justice, while public spending in education or health
might be perceived as complements for private sector provided services.
Private investment, a much more cyclically volatile component of output, may
also be influenced by tax and government spending. The incentive to invest is
responsive to tax policy and is likely to be more responsive when tax measures
are perceived to be temporary (in this respect see for example Auerbach and
Hassett, 2002). The rationale is the following. Firms and investors are sensitive to
changes over the coming period in the tax-adjusted price of new capital goods,
and may be motivated to accelerate purchases into this year if a favourable tax
environment is expected to become less favourable. This might be particular-
ly the case in the presence of capital stock adjustment costs, as expectations of
future changes in the incentive to use capital in production lead to immediate
changes in investment so as to minimize the adjustment costs incurred in closing
the gap between the current and future desired capital stocks. Thus, temporary
tax credits may have more than proportional impact on the user cost of capital.
Most empirical studies on temporary investment incentives find that they tend
to be only moderately effective (see, for example, CBO, 2008, and the literature
cited there). This may be due to the fact that investment projects often require
long planning phases and, consequently, only projects that have already been
planned can be implemented in the short term.
Standard models without liquidity constraints or price and wage stickiness
would predict a boost in investment after a government spending shock given
that, to compensate for the negative wealth effect caused, agents might decide to
work more, which in turn will raise the return to capital. Nevertheless, other ar-
guments would signal that a positive government spending shock might lead to
a situation in which private investment is crowded out by higher public debt is-
suance, if the latter raises the interest rate (this will depend on current and future
7
This adds to the usual argument that expansionary fiscal policy is more efficient when the output gap is nega-
tive because otherwise it could only boost inflation (see Henry et al., 2004).
8
See for example Fiorito and Kollintzas (2004) and Ganelli and Tervala (2009) for theoretical justifications and
empirical evidence on the complementarities argument, and Linneman and Schabert (2004) for the imperfect
substitution one. At the end of the day, the issue of whether private and public consumption are complements
or substitutes is an empirical one.
8

Download
Pros and Cons of various fiscal measures to stimulate the economy

 

 

Your download will begin in a moment.
If it doesn't, click here to try again.

Share Pros and Cons of various fiscal measures to stimulate the economy to:

Insert your wordpress URL:

example:

http://myblog.wordpress.com/
or
http://myblog.com/

Share Pros and Cons of various fiscal measures to stimulate the economy as:

From:

To:

Share Pros and Cons of various fiscal measures to stimulate the economy.

Enter two words as shown below. If you cannot read the words, click the refresh icon.

loading

Share Pros and Cons of various fiscal measures to stimulate the economy as:

Copy html code above and paste to your web page.

loading