## IMF Survey: Making Fiscal Stimulus Effective During Downturns

_IMF News, October 2, 2008_

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## Bibliographic details
- Authors: Alasdair Scott IMF Research Department October
- Published: October 2, 2008

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### POLICY RESPONSES TO SLOWDOWNS
- Tax cuts or spending increases that make debt unsustainable are likely to cause output to fall, not rise.
- Key challenge: ensure discretionary fiscal policy measures—changes in spending and taxation—are delivered quickly and do not cause concerns about future debt sustainability.
- Discretionary fiscal measures:
  - Typically slower to arrive than monetary policy responses.
  - Often become permanent, implying that public debt creeps upward.
- Automatic stabilizers:
  - Respond naturally as the economy fluctuates (for example, increases in spending on unemployment benefits during downturns).
  - Provide a symmetric response over the cycle, avoiding the easing bias seen in discretionary measures.

### ROLE OF FISCAL POLICY
- Fiscal stimulus is a potential tool for countering economic slowdowns, but it must be timely, targeted, and temporary to be effective.
- Historical patterns:
  - Advanced economies: discretionary fiscal policy has typically been countercyclical (taxes cut and spending increased during downturns).
  - Emerging economies: fiscal policy has often been procyclical (stimulus added during good times and removed during downturns), tending to destabilize rather than smooth fluctuations.
- Example of policy action: the United States responded with the Economic Stimulus Act, passed in February 2008.

### RESPONDING TO BUSINESS CYCLE CHANGES
- The three "Ts" policymakers should assess: timely, targeted, and temporary.
- Common practical problems:
  - Discretionary fiscal policy has usually been used less frequently than monetary policy during downturns and has taken longer to arrive—often after it is needed.
  - Discretionary policy typically shows an easing bias—more tax cuts and spending increases during downturns than tax increases and spending cuts during upturns—causing debt to creep upward.
  - Automatic stabilizers have the advantage of responding symmetrically and immediately.

### EFFECTS ON ECONOMIC ACTIVITY
- New evidence finds discretionary fiscal policy can have moderately countercyclical effects, with important caveats and differences between advanced and emerging economies.
- Key quantitative finding:
  - On average, for all economies, a discretionary stimulus package equivalent to 1 percent of country's GDP is associated with GDP increases of about 0.1 to 0.2 percent.
- Longer-term effects:
  - Advanced economies: longer-term effects are positive and possibly higher.
  - Emerging economies: longer-term effects are typically negative.
- Channels explaining weaker outcomes in emerging economies:
  - Debt sustainability concerns may lead households and firms to anticipate higher taxes or inflation in the future.
  - International capital markets may impose higher interest rates to insure against these risks.
  - Resulting behavior: households save more (reducing demand) and firms invest less.

### MAKING FISCAL POLICY MORE EFFECTIVE
- Preconditions for using discretionary fiscal policy:
  - Improve fiscal positions during good times.
  - Credibly commit that stimulus packages are temporary.
- Composition matters:
  - Policy changes based on cutting taxes appear to be more successful at stimulating growth than those based on increased spending.
  - Fiscal changes need coordination with monetary policy goals—particularly because increased spending can create pressure on prices.
- Strengthening automatic stabilizers:
  - Automatic stabilizers respond immediately and symmetrically, keeping public debt stable over the business cycle.
  - Policymakers could design tax, transfer, or spending programs to be linked directly to the state of the economy to strengthen stabilization effects.
- Enhancing credibility of discretionary measures:
  - Changes in fiscal governance could reduce debt bias, including placing more emphasis on transparent evaluations of the state of the economy and longer-term implications of fiscal measures.

*Source: IMF Survey: Making Fiscal Stimulus Effective During Downturns, Alasdair Scott, IMF Research Department, October 2, 2008*

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## Content in this bundle

- [5sumpdf (PDF)](/-/media/websites/imf/imported/external/pubs/ft/weo/2008/02/pdf/_5sumpdf.pdf){rel="external" type="application/pdf"}
- [C5pdf (PDF)](/-/media/websites/imf/imported/external/pubs/ft/weo/2008/02/pdf/_c5pdf.pdf){rel="external" type="application/pdf"}

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## References

- [https://www.imf.org/en/News/country-focus](https://www.imf.org/en/News/country-focus)
- [PRESS CENTER](http://presscenter.imf.org/)
- [IMF Research](https://www.imf.org/en/news/search)
- [Video: author's summary](https://www.imf.org/external/mmedia/view.asp?eventID=1250)
- [Crisis marks tectonic shift](https://www.imf.org/external/pubs/ft/survey/so/2008/NEW092508A.htm)
- [Crisis hits global economy](https://www.imf.org/external/pubs/ft/survey/so/2008/NEW091708A.htm)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sores100208b_