Contrary to conventional wisdom, government stimulus can improve the health of the economy for years after, without inflationary side effects
The following is a summary of a paper the authors presented at INET’s secular stagnation conference in December 2017. Their full paper is here.
The Research Question
- Some economists as well as public commentators increasingly question (pre-crisis) conventional wisdom that the economy never persistently deviates from an optimal normal and that attempts to expand the economy by means of demand management are likely to be inflationary
- In the face of the failure of GDP to return to pre-crisis path, several papers have shown persistent effects of negative demand shocks, but failed to assess what happens in the opposite case
Our paper looks at the long-term effect that expansions (that is positive shocks) of a demand variable (public spending plus exports) cause on average over a ten-year period
We find an increase in GDP, employment, capital stock, labor force participation, and productivity, and a fall in unemployment, with no inflationary consequences.
We assess such effects by measuring the average variation of each variable after an expansion relative to a control group of countries that have not experienced the positive shock.
- The gap of GDP in “treated” and “control” units stabilizes toward the end of the 10 years period and there is no sign of a return to an independent path
- Changes in demand can have persistent effects also on employment and on ‘supply side’ factors such as capital endowment, labor force participation, productivity
- The effects on inflation are not statistically significant and on average small and short-lived
- These effects are not limited to “special circumstances” (that is, extreme recessions)
The important theoretical implication is that standard accounts that claim that expansionary fiscal policies should be reserved only for cases of extreme recession are misleading.
In terms of policy: public budget policies are very important in determining the long-term health of the economy.