Does Fiscal Stimulus Work?

prisme11Prisme N°11 November 2007

Edouard Challe

Also available in German

Prisme N°11 November 2007 (254.3 KiB)

This article examines the way in which fiscal policy impulses (variations in government spending and tax cuts) affect aggregate variables such as GDP, consumption, investment and employment.
Economic theory distinguishes three potential channels of transmission for these impulses, according to whether they affect the equilibrium through their wealth effects, their aggregate demand effects, or their liquidity effects.
We therefore intend to evaluate the extent to which these theoretical channels are consistent with the empirically observed impacts of fiscal stimulus. Although economists have traditionally focused their attention on wealth effects and aggregate demand effects, traditionally associated with the “classical” and “Keynesian” paradigms, recent works on the subject show that liquidity effects also play an important role. Finally, in the presence of aggregate demand effects and liquidity effects, fiscal stimulus is all the more effective over the short term when it is financed by government debt issue. The gains achieved through debt-financed stimulus can, however, conflict with the social costs resulting from high levels of long-term public debt, and this raises a specific problem concerning the dynamic consistency of fiscal policy.