Fiscal Policy Re-Assessed
The recession the United Kingdom experienced in 2010-2011 suggests that the United States' decision to increase government spending was the correct course of action, economist Menzie Chinn suggests in the spring La Follette Policy Report.
Chinn is among the economists who argue that using government spending cuts and tax increases to close a national budget deficit stymies economic growth. His essay charts how that train of thought — considered outdated thinking six years ago, when the world's economy dropped into the Great Recession — has gained credibility.
Chinn describes how additional government spending ultimately increases households' disposable income and thus encourages consumption, which in turn stimulates more demand. The 2009 American Recovery and Reinvestment Act provided that stimulus in the United States, replacing lost private spending with public funds.
"In the end, the U.S. economy moved from contraction to expansion in the third quarter of 2009—when the stimulus package spending and tax cuts came online," says Chinn, whose article started as an observation made on his blog, Econbrowser.com. "And around the world, countries where governments increased their spending to provide stimulus found that their economies turned around."
In contrast, the United Kingdom followed a policy of fiscal consolidation, with higher taxes and reduced government spending in 2010 — and saw its per-capita income stagnate and its economy go back into recession, Chinn says.
Elsewhere in Europe, the European Central Bank and International Monetary Fund pressured countries with large debt, including Greece and Spain, to also practice fiscal consolidation. Chinn's analysis shows that the greater the budget deficit, the slower the economic growth — again suggesting that fiscal expansion is what grows the economy, Chinn says.
In the United States, the economy might have grown even faster had federal, state and local governments spent even more, Chinn adds.