Journal of Economic Perspectives

Activist Fiscal Policy

During and after the “Great Recession” that began in December 2007 (according to the Business Cycle Dating Committee at the National Bureau of Economic Research), the U.S. federal government enacted several rounds of activist fiscal policy. These began early in the recession with temporary tax cuts enacted in February 2008, followed by a tax credit for first-time homebuyers enacted in July 2008. They reached a crescendo in February 2009 with the American Recovery and Reinvestment Tax Act (ARRA): a combination of tax cuts, transfers to individuals and states, and government purchases estimated to increase budget deficits by a cumulative amount equal to 5.5 percent of one year’s GDP. The fiscal stimulus continued thereafter with more targeted measures, notably the temporary “cash for clunkers” program in summer 2009 aimed at stimulating the replacement of old cars with new ones, and an extension and expansion of the First-Time Homebuyer Credit in November 2009 and July 2010. Accompanying these fiscal efforts were the Troubled Asset Relief Program, enacted in fall 2008 to address the financial crisis, and a continuing array of interventions by the Federal Reserve Board that aimed to stabilize credit markets and stimulate the economy.

Around the world, other countries caught in the grip of recession also pursued a variety of active fiscal strategies, ranging from temporary consumption tax rebates (for example, in the United Kingdom) to large public works projects (notably in China). The prevalence of fiscal policy interventions in this period reflects both the severity of the recession and a revealed optimism with regard to the potential effectiveness of activist fiscal policy. Yet the variety of policies adopted also suggests uncertainty about which approaches might have been most effective.

In this paper, we review the recent evolution of thinking and evidence regarding the effectiveness of activist fiscal policy. Although fiscal interventions aimed at stimulating and stabilizing the economy have returned to common use, their efficacy remains controversial. We review the debate about the traditional types of fiscal policy interventions, such as broad-based tax cuts and spending increases, as well as more targeted policies. We conclude that while there have certainly been some improvements in estimates of the effects of broad-based policies, much of what has been learned recently concerns how such multipliers might vary with respect to economic conditions, such as the credit market disruptions and very low interest rates that were central features of the Great Recession. The eclectic and innovative interventions by the Federal Reserve and other central banks during this period highlight the imprecise divisions between monetary and fiscal policy and the many channels through which fiscal policies can be implemented.