GOLDMAN: New Research Shows That Spending Cuts Now Will Be A Disaster

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.

Here’s Stehn:

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.

Here’s DeLong’s post on the presentation >

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at