The theory of the fiscal stimulus: how will a debt-financed stimulus affect the future?

• W. Max Corden
• Melbourne Institute of Applied Economic and Social Research

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29 June 2009Conservative critics of Keynesian fiscal stimulus policies usually criticise such policies because of the increase in public debt that results. Hence a burden on future taxpayers would be imposed. But there are qualifications. Firstly, if there is an initial output gap that cannot be eliminated with monetary policy, fiscal expansion will increase current output, and this will lead not only to higher current consumption but also to higher savings. These savings will yield a benefit for the future. Secondly, if at least some of the stimulus finances public investment, for example in infrastructure, there are also likely to be benefits for the future.

The paper also discusses money-financing of the deficit, the automatic stabilisers, and exchange rate effects of a fiscal stimulus. Finally, it underlines the need for a unified policy that produces both fiscal surpluses in a boom and deficits in a slump.