Does the Effectiveness of Fiscal Stimulus Depend on Economic Context?

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The topic of this session of the INET conference is a question: does the effectiveness of fiscal policy in stabilizing an economy depend on the underlying economic context in which the policy is implemented?

The answer to such a broad question must certainly be yes, but I argue here that the answer differs across dimensions of “context.”

I explore three such dimensions. First, I consider in some detail the most obvious context: the state of actual economic activity relative to some measure of the economy’s potential. I discuss logic and evidence, including some new empirical research supported by INET that implies the presence or absence of idle resources is the key context for fiscal policy. Second, I explore whether the openness of the economy matters, especially the extent to which fiscal stimulus flows abroad by boosting imports or is financed by borrowing from abroad. While this dimension will likely affect the quantitative “bang for the buck” that a country gets from fiscal expansion, I conclude that the open-economy context is unlikely to much affect the decision of a country that borrows in its own currency to undertake fiscal stimulus. Third, I look at whether the level of government debt, what might be called the “debt overhang” matters for the decision to undertake fiscal stimulus. While I accept that government debt can, in principle, be excessive, I discuss why concerns about the level of debt developed, sovereign-currency countries have in the current circumstances are likely exaggerate.