TAILIEUCHUNG - The Myth of Expansionary Fiscal Austerity

In short, there is little reason to believe that a fiscal adjustment will lead to a substantial improvement in the United States’ trade position any time in the near future. This channel for offsetting the contractionary impact of deficit reduction is not very promising. The investment channel does not appear much more promising. With interest rates already at historic lows, it seems implausible that whatever further decline may occur as a result of adjustment could have very much impact. In most sectors output remains far below capacity, so firms have little incentive to expand capacity far. | lilt SSL RESEARCH The Myth of Expansionary Fiscal Austerity Dean Baker October 2010 Center for Economic and Policy Research 1611 Connecticut Avenue NW Suite 400 Washington . 20009 202-293-5380 CEPR The Myth of Expansionary Fiscal Austerity I Contents The Effects of the Great The Logic of an Expansionary Fiscal The Goldman Sachs Case for Expansionary About the Author Dean Baker is an economist and Co-director of the Center for Economic and Policy Research in Washington . Acknowledgments The author thanks Eileen Appelbaum David Rosnick John Schmitt and Nicole Woo for helpful comments and suggestions. CEPR The Myth of Expansionary Fiscal Austerity 1 Introduction Recently governments economists and international financial institutions have been debating the merits of further fiscal stimulus to combat the Great Recession versus fiscal austerity or adjustment that is higher taxes and or lower government spending to combat budget deficits. Some supporters of austerity have gone as far as arguing that fiscal adjustment could restore economic growth. These analyses are being touted to oppose increased stimulus to boost the economy. This paper examines the arguments for austerity and demonstrates that current economic conditions in the United States do not support the case for fiscal adjustment. The Effects of the Great Recession The Great Recession has led to the longest sustained period of high unemployment in the post-war era. The unemployment rate in the United States was percent in August percentage points above the Congressional Budget Office s CBO estimate of the rate we would have if the economy were now operating at its full capacity and percentage points above the low point hit in 2007 before the This large unemployment gap would seem to argue for aggressive fiscal and monetary stimulus. CBO also calculates that the gap between potential .

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