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Fiscal Stimulus: A Neoclassical Perspective

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  • Strulik, Holger
  • Trimborn, Timo

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.

Suggested Citation

  • Strulik, Holger & Trimborn, Timo, 2009. "Fiscal Stimulus: A Neoclassical Perspective," Hannover Economic Papers (HEP) dp-421, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  • Handle: RePEc:han:dpaper:dp-421
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    File URL: http://diskussionspapiere.wiwi.uni-hannover.de/pdf_bib/dp-421.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Strulik, Holger & Trimborn, Timo, 2011. "The Dark Side of Fiscal Stimulus," Hannover Economic Papers (HEP) dp-466, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    2. Clausen, Volker & Wohltmann, Hans-Werner, 2011. "Oil Price Shocks and Cyclical Dynamics in an Asymmetric Monetary Union," Ruhr Economic Papers 247, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    3. repec:zbw:rwirep:0247 is not listed on IDEAS
    4. repec:got:cegedp:150 is not listed on IDEAS
    5. Volker Clausen & Hans-Werner Wohltmann, 2011. "Oil Price Shocks and Cyclical Dynamics in an Asymmetric Monetary Union," Ruhr Economic Papers 0247, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.

    More about this item

    Keywords

    deficit spending; government spending multiplier; economic recovery; economic growth;

    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, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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