Stimulus vs. Austerity*

Shyam Sreekumaran NairInstitute of Management Technology Nagpur

*Rangarajan and Sheel, 2013

Post – War period and Oil crisis• Great Depression and New Deal – 1920s and 1930s• Recession of 1937 – War economy• Contractionary stance during periods of excess demand • Fiscal policy – political minefield – monetised deficit• Oil crisis – 1970s – stagflation• Monetary tightening – controlling inflation• “automatic stabiliser” sufficient – cyclical deficit – Maastricht

treaty – structural deficit or discretionary fiscal policy not required

Great recession and resurrection• The 2008 global recession – revival of discretionary fiscal

policy• Global economic growth in second half of 2009 – “this

recovery was fleeting as it was on monetary and fiscal life support” – private investment and consumer confidence never returned – by 2011, global economy on downward path

• Appropriateness of fiscal policy

Typology of growth crises• Type A: decline in growth because of demand slackening over

the business cycle – spare capacity and disinflationary pressure

• Type B: decline in growth because of a collapse in demand caused by financial crises/deleveraging - rising inflation and falling growth

• Type C: decline in growth because of a collapse in demand caused by financial crises/deleveraging – spare capacities and deflationary pressure

Type A crises• Small dose of fiscal stimulus – decline in private demand

cyclical • Fiscal expansion sticky – inflationary pressure• Western economies – mix of automatic stabilisers and

independent monetary policy• Caveats – higher net exports – Ricardian equivalence –

leakage overseas

Type B crises• Stimulus – stagflation• Administrative action required • If not, “combination of adjusting to the decline in growth over

the short term and structural reforms over the medium term to raise growth potential is possibly the optimal strategy” – politically challenging though

Type C crises• Stimulus ineffective – Ricardian equivalence and deleveraging• Fiscal multipliers will be higher• Optimum fiscal strategy – accelerate deleveraging and design

a policy mix that will minimise the effect of Ricardian equivalence

• Caveats – external demand – “overstimulation” – capital expenditure

Fiscal Stimulus in current growth crises

• Fiscal deficit worsened in all the countries – not necessarily structural though

• Stimulus high in US, UK and Japan – Low in Germany and Euro area – BRICS economies grew and did not witness a significant increase in their debt ratio

• Fiscal tightening post 2010 resulted in fall in growth across the world

• Fiscal multiplier has been low – size of the public sector – deleveraging

• Without structural reforms stimulative policies not sustainable – eventual fiscal exit strategy needs to be planned

Improving fiscal multipliers• Growth rate in all countries low• Fiscal stimulus vital – Ricardian equivalence • Balance between consumption and investment constitutents

of fiscal stimulus• Infrastructure investment