Is More Fiscal Stimulus Needed?

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In The Media

Is More Fiscal Stimulus Needed?

Countries that can afford to continue to spend, including the United States, should not abandon fiscal stimulus until the private sector recovery is clearer.

By Uri Dadush

Published on Jul 15, 2010

Source: Council on Foreign Relations

Is More Fiscal Stimulus Needed?Fiscal stimulus is neither as effective as its advocates claim nor as expensive as its opponents claim. According to the OECD and IMF, stimulus spending may only have prevented one-fifth of the 5 percentage point increase in unemployment during the crisis and accounted for one-fourth of the 7.5 percent drop in deficit-to-GDP ratios in advanced countries. Nevertheless, the decision of whether or not to continue fiscal stimulus should be based on three considerations:

The state of the global recovery. It is happening, but we are not out of the woods yet. The global economy has been growing for at least a year, but unemployment and excess capacity remain high, and private demand growth shows signs of slowing. Though emerging markets are still pulling world demand, Europe's debt crisis poses a big threat.

The capacity of monetary policy to keep the recovery going. With inflation still subdued, monetary policy can remain expansionary for the foreseeable future. Its effectiveness will be undercut, however, if risk-appetites falter and lenders hoard cash. Furthermore, exclusive reliance on monetary policy may create problems later, especially in the overheating, fast-growing emerging markets.

Confidence that countries can repay their debt. Markets continue to let large advanced countries borrow at record-low interest rates despite the 20-30 percent of GDP increase in their debt levels. However, Greece is probably bankrupt, and Spain and other troubled economies in Europe are paying a premium of 150-200 basis points over German rates. These countries have no choice but to reduce their deficits quickly.

Countries that can afford to should continue fiscal stimulus until the private sector recovery is clearer. Among the G7, this group clearly includes the United States, Germany, France, and Canada, and may include Britain and Japan, but not Italy. Further fiscal stimulus is essential in Germany, where domestic demand is stagnant and exports are booming, putting even more pressure on the European periphery. Germany has too much at stake in the euro to pursue mercantilist policies. Booming China's massive stimulus must be withdrawn but gradually and with care, given the international uncertainty.

Originally published by the Council on Foreign Relations, July 15, 2010

About the Author

Uri Dadush

Former Senior Associate, International Economics Program

Dadush was a senior associate at the Carnegie Endowment for International Peace. He focuses on trends in the global economy and is currently tracking developments in the eurozone crisis.

Recent Work

Commentary
The Labors of Tsipras
- Uri Dadush
In The Media
Greece, Complacency, and the Euro
- Uri Dadush

Economy North America United States Western Europe

Carnegie India does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie, its staff, or its trustees.

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