Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/37123
Authors: 
Strulik, Holger
Trimborn, Timo
Year of Publication: 
2009
Series/Report no.: 
Discussion papers // School of Economics and Management of the Hanover Leibniz University 421
Abstract: 
Can a large-scale defcit spending program speed up recovery after recession? To answer that question we calibrate a standard neoclassical growth model with US data and assume that an exogenous shock has driven aggregate output far below steady-state level. We calibrate the model such that a permanent increase of government expenditure is effective in raising output. We then show that 'fiscal stimulus', i.e. a temporary increase of government expenditure is not only ineffective but detrimental. Even before the spending program expires, aggregate output is lower than it could be without fiscal stimulus. We show the generality of this result w.r.t. size and persistence of the shock, size of the government spending multiplier, and the scale and duration of the stimulus program. Using a phase diagram we provide the economic intuition for our unpleasant finding and explain why, generally, private capital stock reaches its lowest level when a deficit spending program expires. We also show how an accompanying temporary cut of capital income taxes helps to prevent the negative repercussion of deficit spending on economic recovery.
Subjects: 
deficit spending
government spending multiplier
economic recovery
economic
growth.
JEL: 
E60
H30
H50
O40
Document Type: 
Working Paper

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