Net Fiscal Stimulus during the Great Recession

• DOI: http://doi.org/10.1111/rode.12039
• Author: Joshua Aizenman,Gurnain Kaur Pasricha
• Date: 01 August 2013
• Published date: 01 August 2013

Net Fiscal Stimulus during the Great Recession

Joshua Aizenman and Gurnain Kaur Pasricha*

Abstract

This paper studies the patterns of government expenditure stimuli among Organisation for Economic

Co-operation and Development (OECD) countries during the Great Recession (2007–2009). Overall, we

find that the USA net fiscal stimulus was modest relative to peers, despite it being the epicenter of the

crisis, and having access to relatively cheap funding of its twin deficits. Of the 28 countries in the sample,

the USA is ranked among the bottom third in terms of the rate of expansion of consolidated government

consumption and investment expenditures. Contrary to historical experience, emerging markets had

strongly countercyclical policy during the period immediately preceding the Great Recession and the Great

Recession itself. Federal unions, emerging markets and countries with very high gross domestic product

(GDP) growth during the pre-recession period saw larger net fiscal stimulus on average than their counter-

parts. We also find that greater net fiscal stimulus was associated with lower flow costs of general govern-

ment debt in the same or subsequent period.

1. Introduction

In the wake of the global crisis of 2008–9 there has been an intense debate about the

efficacy of fiscal policy and the size of fiscal multipliers (Barro and Redlick, 2009;

Ilzetzki et al., 2010; Monacelli et al., 2009; Spilimbergo et al., 2009). This paper takes a

positive perspective on these issues: in order to take a position on the effectiveness of

fiscal policy, it is important to first measure the size of the net fiscal stimulus by the

general government. The impact of a given increase in government spending (G)on

gross domestic product (GDP) can be measured as the fiscal multiplier times the net

fiscal stimulus, i.e.

ΔΔGDP Fiscal Multiplier G=×

While much of the debate has focussed on the size of fiscal multipliers, having a

measure of the magnitude of fiscal stimuli enacted is a necessary condition for under-

standing the impact of fiscal policy.1In this paper, we focus on measuring and com-

paring the size of the stimulus itself, rather than dwelling on the size of the multiplier.

With this premise, we investigate four important positive questions associated with

fiscal stimuli in Organisation for Economic Co-operation and Development (OECD)

countries during the Great Recession (2007–2009):

* Aizenman: University of Southern California, Los Angeles, CA 90089, USA. Tel: 1-213-740-4066; Fax:

1-213-742-0281; E-mail: aizenman@usc.edu. Pasricha: Bank of Canada, Ottawa, Ontario, K1A 0G9,

Canada. We would like to thank Kristina Hess for outstanding research assistance. We also thank three

anonymous referees, Daniel Wilson, Robert Lavigne and conference participants at the American Eco-

nomic Association Meetings in Denver, January 2011 for comments. The views expressed in the paper are

those of the authors. No responsibility for them should be attributed to the Bank of Canada or to the

National Bureau of Economic Research.

Review of Development Economics, 17(3), 397–413, 2013

DOI:10.1111/rode.12039

© 2013 John Wiley & Sons Ltd

1. How large was the fiscal stimulus? In particular:

(a) Which OECD countries had the largest fiscal stimuli during the Great Reces-

sion and which countries simulated least? Did the USA, a country that was the

epicenter of the crisis, and that enjoys an exorbitant privilege (i.e. relatively

easy funding of its fiscal and current account deficits), engaged in larger fiscal

stimuli than other countries?

(b) Was the size of stimulus related to certain characteristics of countries, viz. their

status as federal unions, emerging markets, members of the European Mon-

etary Union (EMU)?

2. How countercyclical was fiscal policy in OECD countries? A large literature has

shown that fiscal policy tends to be counter-cyclical in developed countries and

pro-cyclical in emerging markets. We ask if the same pattern held for the most

recent business cycle.

3. Did countries that enact larger fiscal stimulus have to face higher flow costs of

public debt? Did markets penalize countries that stimulated more?

4. Who delivered the stimulus—federal or state governments?

To answer these questions about the size of the fiscal stimulus during the Great

Recession, we use quarterly data on the pure fiscal expenditures of the consolidated

government, the central government and the state and local governments for OECD

countries. Pure fiscal expenditure is the real consumption and investment expendi-

ture (Cg+Ig) at any level of government. It is the “G” or the consolidated govern-

ment expenditure in the national income identity, which is relevant for computing

the Keynesian fiscal expenditure multiplier. We refer to increases in Gas “net fiscal

stimulus” or “pure fiscal expenditure stimulus”.2It is important to remember that

the “G” in the national income identity does not include transfers—unemployment

benefits, financial bailouts, etc.—and therefore these are excluded from this study as

these would stimulate the economy only to the extent that these are spent, and evi-

dence indicates that private savings rate increased during the Great Recession

(Mody et al., 2012).3Further, our focus on government spending is in contrast with

another branch of literature which defines countercyclical fiscal policy as one with

positive correlation between fiscal surplus and output. Following the paper pub-

lished in NBER Macroeconomics Annual by Kaminsky et al. (2004), we focus on

government instruments to smooth business cycles, not on outcomes like fiscal

deficit or surplus, which are endogenous and may lead to misleading conclusions

about the fiscal policy stance. For example, the government may be raising tax rates

in the recession and cutting expenditure, yet running a fiscal deficit because the tax

base is smaller.

We restrict the analysis to OECD countries as the countries in the groups are

good comparators for each other, with relatively advanced, market based econo-

mies. Moreover, the policy debate on the efficacy of fiscal multipliers centered on

these economies. Our results should not be interpreted to be relevant to all econo-

mies in all periods, but rather to describe the experiences of a set of major world

economies during the most recent crisis. OECD members include some countries

that are also considered emerging markets, like Korea, Mexico, Chile, and Turkey.

Some OECD members are federal unions or “federations”, i.e. they have a constitu-

tionally guaranteed separation of powers between the center and the regional gov-

ernments, like the USA, Canada, Australia, etc, while others are non-federal

unions.4This heterogeneity allows us to look at differences between different groups

of countries. We are particularly interested in comparing federations with non-

398 Joshua Aizenman and Gurnain Kaur Pasricha

© 2013 John Wiley & Sons Ltd