Lawrence Summers, a former economic adviser to President Barack Obama, and Brad DeLong, a University of California professor, say short-term fiscal stimulus is effective medicine for a deep contraction and can pay for itself, according to a paper released today.
“Discretionary fiscal policy where there is room to pursue it has a major role to play in the context of severe downturns that take place in the aftermath of financial crises,” the economists said in a paper delivered at the Brookings Institution in Washington.
The economists write that if a central bank’s policy interest rate is stuck at zero for a long period, that could reduce the cost of fiscal policy and make it more effective. “When the zero lower bound constrains interest-rate movements, the impact of fiscal policy will be magnified,” according to Summers and DeLong.
Deep contractions can also cast long shadows over subsequent expansions, a phenomenon known as “hysteresis,” the economists write. For example, the current expansion, which began in June 2009, hasn’t been strong enough to push the unemployment rate below 8 percent.
Moderate growth and low inflation are two reasons why the Federal Reserve has kept its benchmark lending rate near zero since December 2008.
In these conditions, acceleration in gross domestic product resulting from fiscal stimulus can raise tax revenue and make up for the added spending.
“A combination of low real U.S. Treasury borrowing rates, positive fiscal multiplier effects, and modest hysteresis effects is sufficient to render fiscal expansion self-financing,” the economists write.
DeLong, who teaches at the University of California’s Berkeley campus, was a deputy assistant secretary of the U.S. Treasury under former President Bill Clinton.