What are some of the potential advantages of expansionary fiscal policy?
If you were asked to evaluate demand side policies, what points could you make for employing expansionary fiscal policy? A student of mine asked the other day and here is what we came up with:
Fiscal policy is direct: any increase in government spending will automatically increase by at least as much, if not more, national income (but remember the Barro argument I pointed out in an earlier post)Just some ideas. Comments are welcome....
If the multiplier is greater than one, then it is also a powerful tool to lift an economy from recession (but remember the Mankiw - Krugman/Romer disagreement that was pointed out in an earlier post; go to Mankiw and Krugman for lots on this)
In an economy in deep recession (or, depression) interest rates may be at or close to zero so monetary policy is totally ineffective; in such a case policymakers have only fiscal policy to turn to (in the US interest rates are already virtually zero, so there is no room for easier monetary policy)
If the institutional framework of the economy is equipped with unemployment benefits and a progressive income tax system then policymakers have the benefits of built-in stabilizers (concerning unemployment and other benefits, the EZ12 is more equipped than the US is; this was Germany’s and France’s argument against a ‘coordinated’ fiscal push even though they may be just hoping for the US leakages (US imports from the EZ) which are EZ injections (EZ exports to the US))
If the increased government expenditures of a stimulus package include spending on infrastructure (defined as physical capital typically financed by governments that create massive positive externalities i.e. roads, bridges, harbors, telecommunications etc), health and education, then a long run positive supply-side effect will also result
If the increased government expenditures of a stimulus package include spending on the development of ‘green’ technologies than an additional long run benefit will be the improved environment, giving a better chance to sustainable growth.
A decrease in taxes as part of an expansionary stimulus plan may also have beneficial supply-side effects as lower taxes may improve incentives to work and to invest (a well known albeit perhaps somewhat controversial supply-side argument)