Effectiveness of Fiscal Policy as a Stabilization Tool

The Effectiveness of Fiscal Policy as Stabilization Policy Alan J. Auerbach University of California, Berkeley July 2005 This paper was presented at the Bank of Korea International Conference, The Effectiveness of Stabilization Policies, Seoul, May 2005. I am grateful to my discussants, Takatoshi Ito and Chung Mo Koo, and other conference participants for comments on an earlier draft. I. Introduction Perspectives among economists on the usefulness of fiscal policy as a device for macroeconomic management have moved back and forth over the years. Belief in the active use of the tools of fiscal policy may have reached a relative peak sometime during the 1960s or early 1970s, and practice followed theory. In the United States,†¦show more content†¦For example, one might wish to announce that the ITC would be eliminated in the future, to spur investment today, but once the future arrived, and today’s investment had already taken place, 2 it might no longer be optimal to repeal the credit. Hence, in addition to the policy lags that made the implementation of policy difficult, one was confronted with two major additional obstacles: first, to figure out how to evaluate potential policies and, second, to recognize that agents react not to policies that are announced, but to policies that are expected. To these three hurdles, policy lags, model instability, and dynamic inconsistency, the literature added several others. There was, of course, the problem that estimates of behavioral responses to fiscal policy were just that – estimates of parameters, not the parameters themselves. Even with a stable model, i.e., one based on exogenous taste and technology parameters, uncertainty about model parameters militated against activism, as shown by Brainard (1967). Moreover, determining the â€Å"right† behavioral model is a difficult task, given that all models involve simplifying assumptions, and some models of ho usehold and firm decisions suggested that fiscal policy changes would be ineffective. For example, there has been a long debate in the investment literature about the importance of the user cost of capital as a determinant of investment, relating to suchShow MoreRelatedRole Of Politics In Macroeconomics729 Words   |  3 Pagesthrough intervention on monetary, fiscal policies and increased government spending during recessions. Some of these political divisions are based on political alliances and belief structures rather than an impartial macroeconomic analysis. 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