Over at Marginal Revolution, Tyler Cowen nicely breaks down what a massive fiscal boost can and cannot accomplish:
I feel like I am repeating myself, but since the topic is so much in the news, let's give it another go. A massive fiscal policy could:
1. Generate some investments which are worthwhile on their own terms. LaGuardia really does need another runway.
2. If the broader monetary aggregates are falling, because of either a credit crunch or a liquidity trap, a fiscal boost can keep aggregate demand from deteriorating. Note that this is distinct from bringing about a recovery; it is limiting further downside.
3. A fiscal boost can provide a beneficial "sunspot" in a multiple equilibrium model, thereby moving everyone to the higher output equilibrium.
4. If spending needs to fall, a fiscal boost can postpone this fall. Postponing this fall may be a good idea to prevent immediate economic destruction. But then the fiscal policy is not really bringing about recovery. In fact the fiscal policy is (optimally, perhaps) hindering the pace of adjustment and recovery. Fiscal policy makes the downturn less severe but it also prolongs the adjustment process.
You'll note that only under #3 does a massive fiscal boost in fact bring about an economic recovery. But I do not believe that #3 is better for anything than a few good days in the stock market nor do most people rely on #3 in making the case for fiscal policy.
You might also try #5:
5. The economy needs a boost to aggregate demand and since monetary policy isn't working any more, fiscal policy has to step in. This is usually followed by drawing a graph with two or three curves on it.
This makes sense if it is reworded to be more precise and to be some combination of #2 and #4. But still, a huge fiscal boost will not bring recovery because a big chunk of the problem requires real economic adjustments (the simple graph obscures this). The economy needs to adjust out of housing, out of so much consumption, and out of various classes of associated risky assets. Those are some pretty massive adjustments and along the way lots of major banks become zombie banks. A massive fiscal boost won't get us over those problems.
Just to recap: Because of #1 and #2, you might think that a massive fiscal boost is a good idea, compared to the alternatives. But you should not argue that a massive fiscal boost will bring about or drive an economic recovery. It is tempting to cite #5 to justify the fiscal boost but the bottom line is some mix of #2 and #4.
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