COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1861

Is Fiscal Stimulus a Good Idea?

Ray C. Fair

May 2012

The results in this paper, using a structural multi-country macroeconometric model, suggest that there is at most a small gain from fiscal stimulus in the form of increased transfer payments or increased tax deductions if the increased debt generated must eventually be paid back. The gain in output and employment on the way up is roughly offset by the loss in output and employment on the way down as the debt from the initial stimulus is paid off. This conclusion is robust to different assumptions about monetary policy. To the extent that there is a gain, the longer one waits to begin paying the debt back the better. 

Possible caveats regarding the model used are that 1) monetary policy is not powerful enough to keep the economy at full employment, 2) potential output is taken to be exogenous, 3) any permanent effects on asset prices and animal spirits from a stimulus are not taken into account, and 4) the model does not have the feature that in really bad times the economy might collapse without a stimulus.

JEL Classification: E17

Keywords: Fiscal stimulus, Multipliers