The Case for Fiscal Stimulus

Governments around the world are now developing massive fiscal stimulus packages that will cause unprecedented budget deficits – a sharp change from the reliance on monetary policy that was used to deal with previous recessions. But the emphasis on fiscal policy is justified, because the current recession is much deeper than and different from previous downturns.

CAMBRIDGE – Governments around the world are now developing massive fiscal stimulus packages that will cause unprecedented peacetime budget deficits. The fiscal deficit in the United States this year is likely to exceed 10% of GDP. A substantial part of the increased deficit will be due to a wide range of new government spending.

Under normal circumstances, I would oppose this rise in the budget deficit and the higher level of government spending. When an economy is closer to full employment, government borrowing to finance budget deficits can crowd out private investment that would raise productivity and the standard of living. Budget deficits automatically increase government debt, requiring higher future taxes to pay the interest on that debt. The resulting higher tax rates distort economic incentives and thus weaken future economic performance.

Of course, some government spending is desirable or necessary. But an increase in government outlays often means wasteful spending that produces less value than consumers would get from those same dollars.

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