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The New View of Fiscal Policy and Its ApplicationJason Furman

Chairman, Council of Economic Advisers

France StratégieParis, France

November 16, 2016

Table of Contents

1

1. Motivation

2. The “New View” of Fiscal Policy

3. Application to the United States and Europe

Table of Contents

2

1. Motivation



Substantial Slack Remains in Europe: Output

3Note: Population data for euro area are quarterly interpolations of annual data.Source: National sources via Haver Analytics; CEA ca lculations.

Euro Area

United States

France

2016:Q3

90

92

94

96

98

100

102

104

106

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Real GDP per Capita: Euro Area, United States, and FranceIndex (Pre-Crisis Peak = 100)

Substantial Slack Remains in Europe: Employment

4Source: National sources via Haver Analytics; CEA ca lculations.

Euro Area

United States

France

0

2

4

6

8

10

12

14

1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Unemployment RatePercent

Oct-2016

Substantial Slack Remains in Europe: Inflation

5

Note: Data for euro area and France are for the Harmonized Index of Consumer Prices (HICP) excluding energy and unprocessed food. Data for United States are for the Consumer Price Index for Al l Urban Consumers (CPI-U) excluding food and energy.Source: National sources via Haver Analytics; CEA ca lculations.

Euro Area

France

United States

Sep-16

0

1

2

3

4

5

6

1990 1995 2000 2005 2010 2015

Core Consumer Price InflationPercent Change, Year-over-Year

Part of the Difference is Due to More Expansionary U.S. Fiscal Policy at the Onset of the Crisis

6Note: Fiscal expansion calculated as the difference between the primary fiscal balance compared to 2007. Asterisks (*) indica te projections.Source: International Monetary Fund, Fiscal Monitor (October 2016).

0

2

4

6

8

10

12

2008 2009 2010 2011 2012 2013 2014 2015 2016* 2017*

United States

France

Euro Area

Fiscal ExpansionPercent of Potential GDP

We All Need to Be Better Prepared for the Next Downturn

7

Note: Bars represent the difference between peak Federal funds rate prior to onset of recession and trough Federal funds rate during or after recession. For 2007-09 recession, the trough rate used is the lower bound (0.00 percent) set by the FOMC.Source: Federal Reserve Board; CEA ca lculations.

-681

-550-525

-800

-700

-600

-500

-400

-300

-200

-100

0

1990-91 Recession 2001 Recession 2007-09 Recession

Total FOMC Reductions to Federal Funds Ratein Response to Past Cyclical Downturns

Basis Points

Table of Contents

8

1. Motivation



The “Old View” of Fiscal Policy

9

1. Discretionary fiscal policy is dominated by monetary policy as a stabilization tool.


10


2. Fiscal policy can be ineffective or have bad side effects.


11



3. The biggest fiscal policy priority should be the long-run fiscal balance.


12



3. The biggest fiscal policy priority should be the long-run fiscal balance.

4. If fiscal stimulus is done, it should be very short-run.

Principle #1: Fiscal Policy Can Effectively Complement Monetary Policy

13Source: National Sources via Haver Analytics.

France

Japan

United Kingdom

Germany

United States

2015

-3

-2

-1

0

1

2

3

4

5

6

7

8

1985 1990 1995 2000 2005 2010 2015

Real 10-Year Benchmark Rate in Selected CountriesPercent

Principle #1: Fiscal Policy Can Effectively Complement Monetary Policy

14

19962000

20052010

2015

0

1

2

3

4

5

6

7

8

1995 2000 2005 2010 2015 2020 2025

PercentTen-Year Treasury Rates and Historical Economist Forecasts

Note: Forecasts are those reported by Blue Chip Economic Indicators in March of the given calendar year, the median of over fifty private-sector economists. Source: Blue Chip Economic Indicators.

Principle #2: Fiscal Policy Can Be Very Effective in Practice

15

• Large multipliers (Romer and Romer 2010)

• Evidence multipliers are larger in downturns (Nakamura and Steinsson 2014; Parker et al. 2013)

• Evidence multipliers are larger at the effective lower bound

• “Crowding in” of investment instead of crowding out:• Via accelerator (IMF 2015; OECD 2015)• Higher expected inflation → lower real interest rates

(Hall 2009; Christiano, Eichenbaum, and Rebelo 2011; Woodford 2011)

Principle #3: Fiscal Stimulus is Less Constrained by Fiscal SpaceA. Growth May Increase Sustainability in a Weak Economy

16

Baseline

Response

-16

-12

-8

-4

0

4

8

12

–1 0 1 2 3 4

Effect of Public Investment on Debt in Advanced Economies:Low Growth

Percent of GDP

Year

Baseline

Response

-16

-12

-8

-4

0

4

8

12

–1 0 1 2 3 4

Effect of Public Investment on Debt in Advanced Economies:High Growth

Percent of GDP

Year

Note: t=0 i s the year of the shock; dashed l ines denote 90-percent confidence bands. Shock represents an exogenous 1 percentage point of GDP increase in public investment spending. Source: IMF, World Economic Outlook (October 2014).

Principle #3: Fiscal Stimulus is Less Constrained by Fiscal SpaceA. Growth May Increase Sustainability If It is Effective

17Note: t=0 i s the year of the shock; dashed l ines denote 90-percent confidence bands. Shock represents an exogenous 1 percentage point of GDP increase in public investment spending. Source: IMF, World Economic Outlook (October 2014).

Baseline

Response

-16

-12

-8

-4

0

4

8

12

–1 0 1 2 3 4

Effect of Public Investment on Debt in Advanced Economies:High Efficiency

Percent of GDP

Year

Baseline

Response

-16

-12

-8

-4

0

4

8

12

–1 0 1 2 3 4

Effect of Public Investment on Debt in Advanced Economies:Low Efficiency

Percent of GDP

Year

Principle #3: Fiscal Stimulus is Less Constrained by Fiscal SpaceB. Fiscal Progress and Interest Rates

18

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Changes in Spending on Health and Pensions, 2010 to 2030: 2016 IMF Forecasts vs. 2011 IMF Forecasts

Differences in Projected Growth, Percentage Points

Source: International Monetary Fund, Fiscal Monitor (Apri l 2011, Apri l 2016); CEA ca lculations.

Principle #3: Fiscal Stimulus is Less Constrained by Fiscal SpaceB. Fiscal Progress and Interest Rates (cont.)

19Source: Organisation for Economic Co-operation and Development.

Canada

2017

France

Germany

Italy

Japan

UKUnited States

-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2020

Net Interest Payments on Government DebtPercent of GDP

Principle #3: Fiscal Stimulus is Less Constrained by Fiscal Space:C. Can Combine Short-Run Expansion and Long-Run Consolidation

20Source: Congressional Budget Office (2014); Bureau of Economic Analysis, National Income and Product Accounts; CEA ca lculations; Offi ce of Management and Budget.

2017 Continuation of Current Policies

2011 Continuation of Current Policies

2017 Under President's

FY17 Budget

0

30

60

90

120

150

180

2000 2005 2010 2015 2020 2025 2030 2035 2040

Comparison of Publicly Held DebtPercent of GDP

0

1

2

3

4

5

6

7

8

2009 2010 2011 2012

Recovery Act Subsequent Fiscal Measures Automatic Stabilizers

Program Year

Fiscal Expansion as a Percentage of GDP in Each Program YearPercent

Principle #4: It May Be Desirable to Pursue Sustained Fiscal Expansion

21

0.0

0.4

0.8

1.2

1.6

2.0

0 2 4 6 8 10

Effect of Permanent Increase in Government Investment on Real GDP

Percent Deviation from Baseline

Number of Years

-2.0

-1.6

-1.2

-0.8

-0.4

0.0

0.4

0 2 4 6 8 10

Effect of Permanent Increase in Government Investment on Government Debt-to-GDP Ratio

Percent Deviation from Baseline

Number of Years

Source: Gaspar, Obstfeld, and Sahay (2016).

Principle #5: Fiscal Policy Can Have Positive Global Spillovers

22

Note: Fiscal s timulus is equal to 1 percent of each region’s baseline GDP and is composed of government investment (one-quarter of total stimulus), government consumption (one-quarter of tota l stimulus) and targeted transfers (one-half of total s timulus). Monetary policy accommodates fiscal expansion by keeping th e nominal policy interest rate unchanged for two years.Source: IMF (2016).

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

CoordinatedAcross AllRegions

UnitedStates

Euro Area Japan EmergingAsia

LatinAmerica

World

United States

Euro Area

Japan

Emerging Asia

Latin America

Remaining Countries

Gobal Spillovers: Fiscal Expansion on GrowthImpact of Stimulus on Nominal GDP

Region Where Stimulus Occurs

Table of Contents

23

1. Motivation



Application to the United States: The United States Has Weak Automatic Stabilizers

24

AUSAUT

BEL

CANCHE

DEU

DNKESP FIN

FRA

GBR

GRCIRL

ITA

JPN

KOR

LUX NLD

NOR

NZL

PRT

SWE

USA

0.0

0.1

0.2

0.3

0.4

0.5

0.6

20 30 40 50 60

Government Size and the Cyclical Semi-Elasticity of Automatic Stabilizers

Elasticity (Automatic Stabilizers)

Government Size (Spending to GDP Ratio)

Source: Fatás and Mihov (2012).

Application to the United States: The Procyclical State and Local Government Response to the Great Recession

25

1975

1982

1991

2001

Current Cycle (2009:Q2 Trough)

Average Excluding

Current Cycle

80

90

100

110

120

130

Real State and Local Government Purchases During RecoveriesIndex, Business-Cycle Trough = 100

Source: Bureau of Economic Analysis, National Income and Product Accounts; CEA ca lculations.

Application to the Euro Area

26

• Institutional structure of the euro area—reflecting Old View of fiscal policy—is a barrier to effective policy and has amplified shocks:• No bloc-wide management of macroeconomic policy other than

European Central Bank• Asymmetric coordination via the Stability and Growth Pact (SGP)• SGP focused on current deficits/debt, without incorporating future

liabilities

• Possible solutions:• Do not undermine automatic stabilizers with procyclical

discretionary fiscal policy• Greater coordination of fiscal expansion, especially infrastructure• Enhanced automatic stabilizers, ideally at the euro area-level• Revisions to the SGP or a new multilateral agreement• Euro area fiscal policy

The New View of Fiscal Policy and Its ApplicationJason Furman

Chairman, Council of Economic Advisers

France StratégieParis, France

November 16, 2016

the new view of fiscal policy and its application › sites › default › ... · the “old...

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