Lessons from Failure: Fiscal Policy, Indulgence and Ideology

By Wren-Lewis, Simon | National Institute Economic Review, July 2011 | Go to article overview

Lessons from Failure: Fiscal Policy, Indulgence and Ideology


Wren-Lewis, Simon, National Institute Economic Review


Macroeconomic theory clearly suggests that at the zero lower bound, fiscal contraction will reduce output and slow any recovery. Yet in 2010 the focus of fiscal policy in many countries switched from supporting activity to reducing debt, despite the fact that the recovery from recession often appeared weak. While high levels of public debt can explain this switch in some countries, it does not provide a satisfactory account in others. In addition, the possibility of using balanced budget fiscal expansion or tax switches that bring forward spending remain largely unexplored. This paper suggests that policy has been influenced by an opposition to countercyclical fiscal policy which has ideological roots.

Keywords: Countercyclical fiscal policy; government debt; deficit bias; balanced budget fiscal expansion

JEL Classifications: A14; E62; E63: E65; H63

I. Introduction

"The tragedy of our current economic mess is that the solution to our problems is not, in fact, mysterious--basic macroeconomics, macroeconomics that has worked quite well in the last two years, shows the way. But the men in suits have decided that they know better. "

Paul Krugman, 13/09/10

Over the past thirty years, macroeconomics has made tremendous progress in knowing how to deal with modest macroeconomic shocks. The great moderation period demonstrated that an active monetary policy, coupled with explicit or implicit inflation targets and operated by independent central banks, could stabilise both output and inflation. (1) Unfortunately what is now becoming increasingly clear is that policymakers are not able to deal with large negative macroeconomic shocks.

During the first phase of the current recession, the prognosis about how macroeconomic policy responds to a large negative shock looked more optimistic. Monetary policy cut interest rates rapidly and as far as possible (although with hindsight US policymakers did rather better than those in Europe), and fiscal policy was actively used both in the US, the UK, China and other countries. Lessons from the 1930s appeared to have been learnt. However the use of discretionary countercyclical fiscal policy was opposed by many. Partly as a result, fiscal action was insufficient to prevent large falls in output across the globe.

In 2010 the view of policymakers (the 'men in suits' referred to in Krugman's quote above) changed decisively towards the need for austerity to reduce public debt. The likely consequence is that in many countries the recovery will not close the output gap for a number of years. This will waste a huge amount of resources, and cause widespread unhappiness. So we have a failure of macroeconomic policy: not on the same scale of the 1930s, but a failure of substantial proportions nevertheless. This paper is about why that has occurred.

For many economists policy failure can be put down to the inability of politics to control public debt during the period before the recession: what is often called deficit bias. This is the indulgence referred to in the title. It is clearly the case that past deficit bias has made fiscal expansion more difficult, and for a few countries it has become impossible. However, is high debt a sufficient explanation for why fiscal expansion has been abandoned? This paper makes two points which suggest it is not.

1) Not all countercyclical fiscal policy needs to involve an increase in debt. A failure to use balanced budget fiscal expansions has to be explained some other way.

2) The debt situation has not been a critical problem (a problem that has to be addressed immediately) for many countries. In those countries fiscal expansion today, followed by austerity tomorrow, is technically both feasible and probably optimal from a macroeconomic point of view. It may not be feasible politically, but those who oppose it have not generally focused on this political constraint. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Lessons from Failure: Fiscal Policy, Indulgence and Ideology
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.