Researchers: Fiscal stimulus in downturns is feasible even when debt is high

In order to stimulate a country's economy without permanently bloating its public debt, government spending can play a role, even if the debt is already quite large, researchers told an influential group of central bankers in Jackson, Wyoming.

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"Expansionary fiscal policies adopted when the economy is weak may not only stimulate output but also reduce debt-to-GDP ratios," University of California, Berkeley, professors Alan Auerbach and Yuriy Gorodnichenko said in a paper presented at the Kansas City Federal Reserve's annual economic symposium.

The symposium's focus this year is on how best to foster a stronger global economy.

After the 2007-2009 global financial crisis, fear of ballooning public debt pushed fiscal authorities in some countries to ratchet back government spending, a tactic that economists now think may have slowed recovery.

But with debt levels high by historical standards in many countries, including the United States where debt is about 76 percent of the nation's output, policymakers worry about the drag on growth.

The research presented Saturday offers new evidence that fiscal stimulus in a recession is not only safe but effective even in heavily indebted countries.

That may be particularly welcoming news to central bankers including Federal Reserve Chair Janet Yellen and European Central Bank chief Mario Draghi, who face limited options of their own to combat a future downturn, given existing low interest rates and low inflation rates in their economies.

Politicians in Washington are preparing for a potential showdown over U.S. debt next month, with Treasury Secretary Stephen Mnuchin warning that unless Congress lifts the country's debt ceiling by Sept. 29 the government will no longer be able to pay its bills. Republicans have tried to use past debt ceiling debates as leverage to restrict government spending.

The University of California researchers warned in their paper that fiscal stimulus when an economy is strong can indeed add to debt burdens and slow long-run growth.

"Our results should not be interpreted as an unconditional call for an aggressive government spending in response to a deteriorating economy," they wrote.

Still, they argued, the evidence suggests that fiscal spending during a downturn has less risk of downside than is often thought.

"With tight constraints on central banks, one may expect -- or maybe hope for -- a more active response of fiscal policy when the next recession arrives," they wrote.

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