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Fiscal Stimulus: A Neoclassical Perspective

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Author Info
Strulik, Holger
Trimborn, Timo

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Abstract

Can a large-scale defcit spending program speed up recovery after recession? To answer that question we calibrate a standard neoclassical growth model with US data and assume that an exogenous shock has driven aggregate output far below steady-state level. We calibrate the model such that a permanent increase of government expenditure is effective in raising output. We then show that "fiscal stimulus", i.e. a temporary increase of government expenditure is not only ineffective but detrimental. Even before the spending program expires, aggregate output is lower than it could be without fiscal stimulus. We show the generality of this result w.r.t. size and persistence of the shock, size of the government spending multiplier, and the scale and duration of the stimulus program. Using a phase diagram we provide the economic intuition for our unpleasant finding and explain why, generally, private capital stock reaches its lowest level when a deficit spending program expires. We also show how an accompanying temporary cut of capital income taxes helps to prevent the negative repercussion of deficit spending on economic recovery.

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Paper provided by Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover with number dp-421.

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Length: 27 pages
Date of creation: Jul 2009
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Handle: RePEc:han:dpaper:dp-421

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Related research
Keywords: deficit spending; government spending multiplier; economic recovery; economic growth;

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Find related papers by JEL classification:
E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
O40 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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