Can Contractionary Fiscal Policy Be Expansionary? [January 11, 2013]   [open pdf - 343KB]

"As Congress considers policies to foster economic growth, arguments have been made that the traditional expectations of fiscal policy, namely that cutting spending will contract the economy in the short run, should be reversed. Proponents of this view also argue that cutting spending rather than raising taxes would be a more effective means of increasing economic growth (or at least avoiding contractions). These arguments often refer to recent empirical studies of deficit reductions across countries. This view contrasts with that held by most economists and found in conventional models. In those models cutting spending will contract the economy. Chairman Bernanke of the Federal Reserve was referring to this view when he cautioned against large and immediate spending cuts. Most multipliers (measures of the effect of deficits on the economy) indicate that spending cuts contract the economy more than do similarly sized tax increases. Just as economists generally consider spending cuts to be contractionary in the short run in an underemployed economy, they believe that deficits can be harmful in the long run by crowding out private investment. There is considerable agreement that the continuation of current tax and spending policies will lead to an unsustainable path of the national debt, largely because of the growth of mandates arising from the aging of the population and the growth in health care costs. Thus, to most economists current macroeconomic policy challenges involve a trade-off between the benefits of starting to address the debt problem earlier versus risking damage to a still-fragile economy by engaging in contractionary fiscal policy, or failure to continue with expansionary fiscal policy."

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CRS Report for Congress, R41849
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