Christina Romer\'s paper \"What do we know about the effects of fiscal policy\"

Question

Christina Romer's paper "What do we know about the effects of fiscal policy" and John Taylor's paper "An empirical analysis of the revival of fiscal activism in 2000s" express contrasting views on the effect of the fiscal stimulus packages enacted in the United States in the 2000s.

Question: Which perspective do you find more convincing, and why? Suppose you were reading these papers for their lessons about the effects of fiscal policy on specific emerging market economy, what additional considerations do you think it would be appropriate to bring into the discussion?

For an emerging market economy that you know well, explain whether you think discretionary fiscal policy is a useful instrument. Why or why not?

Explanation / Answer

The perspective of Christina Romer is more convincing as fiscal policy shows its positive impact slowly, but progressively. For example, the impact of stimulus package after the financial crisis of 2008 can be observed in recent economic scenario in the USA when the unemployment rate is 4.1%, GDP growth in the third quarter of 2017 and less number of claims for unemployment benefits is taking place. It is only made possible due to the effective fiscal policy, well complemented by the monetary policy of the Federal Reserve. The perspective is inspired by the Keynesian arguments that price and wages are not flexible in the short run and the economy does not recover on its own and discretionary fiscal policy will accelerate the recovery process.
Though John Taylor identified the policy to be less effective as states spent less, to nullify the impact of increased government spending by the Federal government. But, it is a policy issue where state and Federal government were not working in the same direction. If working together, then the economy could have recovered the earlier and stimulus package will have better and telling impact.
Further, the effectiveness of the fiscal policy is also subjected to the inside lag and outside lag. Inside lag causes the policy makers taking time to recognize a problem and taking time to implement it and outside lag is the time when the policy shows its impact. A consideration of a reduction in inside and outside lag will help to improve the effectiveness of the fiscal policy. Besides, the government has to consider the crowding out effect also that contributes to the nullifying of the effects of fiscal policy. A sensible spending will reduce the crowding out effect.
Yes, in an emerging market economy, discretionary fiscal policy helps in stimulating the demand. It helps consumers to have more disposable income and they consume more as per the MPC and MPS. It creates the aggregate demand and it encourages firms to produce more and increase the supply. Hence, the real GDP grows fast and the economy expands, the key objective of the discretionary fiscal policy.

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