Academic journal article Contemporary Economic Policy

Expansionary versus Contractionary Government Spending

Academic journal article Contemporary Economic Policy

Expansionary versus Contractionary Government Spending

Article excerpt


In response to the global financial crisis, G20 governments implemented unprecedented fiscal stimulus measures aimed at sustaining aggregate demand to bolster national income and employment. Entailing a mix of new public expenditure, tax cuts, and income transfers, fiscal stimulus of any kind was presumed countercyclical and was credited with saving the world from another Great Depression. Many governments, especially in the Organisation for Economic Co-operation and Development (OECD) region, subsequently reversed fiscal stances via controversial austerity measures involving government spending cuts and tax rises due to rising concerns about consequent high budget deficits and the sustainability of public debt levels. In what way, and by how much, fiscal activism affects national income remains a contentious topic of central importance to macroeconomic policy.

The expansive recent literature on deploying fiscal policy as a countercyclical instrument centers on measuring the size of fiscal multipliers for different budgetary instruments and time frames. If multipliers are greater than unity, fiscal stimulus is deemed an effective countercyclical policy instrument since public spending expands economic activity and output by more than the initial public spending increase. Yet if multipliers are negative due to private consumption or investment crowding out effects, or to significant expenditure leakage via imports, "fiscal stimulus" becomes a misnomer since fiscal policy is then procyclical.

A range of theoretical approaches and econometric techniques, mostly vector autoregression (VAR), have yielded mixed results for fiscal multipliers, with estimates varying widely across economies and through time. Some find fiscal multipliers greater than unity, while others do not. See, for instance, Tagkalakis (2008), Makin (2009), Mountford and Uhlig (2009), Auerbach, Gale, and Harris (2010), Cogan et al. (2010), Coleman (2010), Monacelli, Perotti, and Tri-gari (2010), Romer and Romer (2010), Barro and Redlick (2011), Ramey (2011), Woodford (2011), Corsetti, Meier, and Muller (2012), Ravn, Schmitt-Grohe, and Uribe (2012), and Makin (2013). A growing literature also links the effectiveness of government spending as a countercyclical tool to the state of the business cycle (Auerbach and Gorodnichenko 2012; Blanchard and Leigh 2013) and to loan market conditions, including credit frictions (Carillo and PoiIly 2013; Fernandez-Villaverde 2010; Melina and Villa 2013).

To date relatively little has been made of the difference between public consumption and public investment expenditure, and even less of the subsequently defined distinction between productive and unproductive public investment spending. The effects of government investment on the macroeconomy have however been investigated in the real business cycle literature, for instance in an early paper by Baxter and King (1993), while more recently Leeper, Walker, and Yang (2010) have examined the macroeconomic effects of time-to-build lags and investment productivity.

Despite increased globalization of most economies over recent decades, this literature has mainly focused on closed economy effects, ignoring the important distinction between gross domestic product (GDP) and gross national income (GNI) for highly open economies with significant international investment positions.

Economies' international investment positions (11Ps) vary widely around the world. Those with notable net asset positions include Singapore (+224%), (1) Switzerland (+136%), Norway (+96%), Japan (+56%), Germany (+41%), China (+37%), while those with notable net liability positions include the United Kingdom (-35%), United States (-17%), Mexico (-37%), Brazil (-38%), Australia (-65%), New Zealand (-90%), Portugal (-117%), Ireland (-96%), Greece (-114%), and Spain (-93%). These sizeable IIPs imply that significant divergences can arise between measures of a country's GDP and GNI to the extent that relative country rankings in comparative league tables can change (OECD 2005). …

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