Goldman’s Sven Jari Stehn is out with a new note spotlighting new research from economists Larry Summers and Bradford DeLong (who is also a prolific blogger).
The gist: When interest rates are at zero, spending more to stimulate the economy has a long-run effect of helping the fiscal situation. And when rates are at zero (and thus monetary policy is relatively ineffective) spending cuts are disastrous.
In a study presented at the Brookings Panel on Economic Activity on March 22-23 in Washington D.C., Bradford DeLong and Lawrence Summers examine the effectiveness of fiscal policy in a depressed economy. Specifically, they use a simple model to explore the effects of fiscal stimulus in an environment when (1) monetary policy is constrained by the zero bound on nominal interest rates; and (2) a boost to output today brings longer-run benefits for the productive capacity of the economy (for example, by avoiding “scars” or “hysteresis” in the labour market). They call such an environment a “depressed” economy.
They reach two conclusions. First, while the fiscal multiplier is low, perhaps as low as zero, in a normal situation, fiscal stimulus today would be highly effective in affecting output both now and in the future. Second, temporary fiscal stimulus could be self-financing (and may well reduce long-run debt-financing burdens) when one takes into account the effects of present stimulus on the evolution of future output and debt-to-GDP ratios.
Stehn then backs up their work, pointing out that Goldman’s own research shows deleterious effects of fiscal consolidation in times like these:
Photo: Goldman Sachs
This should be very salient given the coming “fiscal cliff” in 2013.
And it sounds like this should be an influential piece of research.