This paper examines the evidence on the impact of stimulus and fiscal
consolidation in the context of a severe economic slump like the Great
Recession. The first part reviews some of the major works on this topic in
the last decade. It notes that the research clearly points in the direction of
stimulus increasing growth during a prolonged slump. The second part
examines the impact of changes in government consumption and
investment on growth, using data from advanced countries since 1980.
Consistent with most prior literature it finds that increases in government
spending during downturns lead to increases in growth. It then constructs
simulations for the period since the Great Recession showing multipliers
in the neighborhood of 1.5. The third part notes new evidence suggesting
that potential GDP appears to have fallensharply as a result of the downturn.
A full model of the impact of stimulus would have to incorporate this
effect which is likely to be large relative to the size of the stimulus.
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Dean Baker, Center for Economic and Policy Research, Baker@cepr.net [2]
David Rosnick, Center for Economic and Policy Research , Rosnick@cepr.net [3]