Academic journal article Economic Perspectives

Measuring Fiscal Impetus: The Great Recession in Historical Context

Academic journal article Economic Perspectives

Measuring Fiscal Impetus: The Great Recession in Historical Context

Article excerpt

Introduction and summary

Fiscal policy describes how the expenditure and revenue decisions of local, state, or federal governments influence economic growth. In this article, we create a comprehensive measure of fiscal policy called fiscal impetus, which estimates the combined effect of purchases, taxes, and transfers across all levels of government on growth. Our goal is to use this measure of fiscal impetus to examine how fiscal policy has behaved during business cycles in the past, how it responded to the most recent recession, and how it is likely to evolve over the next several years. Our analysis reveals that policy was more expansionary than average during the 2007 recession and has been significantly more contractionary than average during the recovery. By the end of 2012, fiscal impetus was below its historical business cycle average and it is forecast to remain depressed well into the future.

Research on fiscal policy typically attempts to measure how a change in tax or spending policies impacts economic outcomes. For example, studies tend to focus on narrow questions such as how a change in eligibility for a safety net program affects unemployment or how infrastructure spending affects gross domestic product (GDP). While there is a vast literature examining the effectiveness of particular fiscal policies, relatively little attention has been devoted to measuring the total contribution of all fiscal policies.

Perhaps the simplest indicator of the stance of overall fiscal policy is the budget deficit. A deficit indicates that government expenditures exceed revenues, a difference that must be financed by borrowing. Assuming that government borrowing does not crowd out private investment, a deficit is stimulative. It means the government is directly purchasing or transferring more than it is bringing in through taxes. Tax cuts and transfers lead to higher private consumption and investment, while direct purchases lead to higher public consumption and investment. However, focusing only on the deficit fails to account for the fact that different fiscal policies may affect economic growth differently. For example, a given level of spending on foreign aid or domestic investment will have the same effect on the budget deficit, though the latter may be more likely to stimulate domestic economic growth.

An alternate approach to measuring the stance of fiscal policy is to use statistical techniques to measure fiscal variables relative to a benchmark or historical norm. Lucking and Wilson (2013) do this by regressing federal taxes, spending, and primary deficits on lags of the Congressional Budget Office (CBO) estimate of potential output. By identifying the historical relationship between federal fiscal policy and the output gap (the difference between potential and current output), they create a baseline against which recent policy can be compared. They argue that federal fiscal policy has been a modest drag on economic growth during the recovery from the Great Recession--because fiscal variables have been less expansionary than would be expected based on the magnitude of the output gap-and that it will continue to be a modest drag.

Many research organizations, such as the International Monetary Fund (Bornhorst et al., 2011) and the CBO (2013a) have divided fiscal policy into structural and temporary/cyclical components. The temporary components aim to measure changes that are direct responses to the business cycle; they can also include the effects of changing asset prices or temporary budget items. Any automatic stabilizers triggered by the tax code or benefit systems are counted as cyclical, while discretionary fiscal policy is counted as structural. Other authors have relied on large-scale econometric models to estimate the effects of policies. These models look at historical data and try to find statistical relationships between changes in fiscal variables and changes in output. …

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