Fiscal Policy After the Financial Crisis by Alberto Alesina and Francesco Giavazzi (review)

In February 2014, the White House Council of Economic Advisors (CEA) reported that the American Recovery and Reinvestment Act of 2009—fiscal policy after the financial crisis—had generated annually 1.6 million jobs and 2–3% points of gross domestic product (GDP) from 2009 to 2011 (CEA). Such claims intrigue macroeconomists.

Identifying empirically how an economy responds to fiscal policy— that is, changes in discretionary government spending or taxing— is very difficult work. Essentially, the challenge is gathering measures of fiscal policy that do not reflect existing or anticipated features of the real economy. Measures that reflect existing features may overstate the effects of fiscal policy. For example, real economic activity and discretionary government spending seem more-strongly related than they actually are if data on discretionary government spending conflate with data on procyclical government spending— which, by definition, rises during expansions and falls during contractions. Conversely, measures that reflect anticipated features may understate the effects of fiscal policy. For example, real economic activity and discretionary government spending seem less-strongly related than they actually are if policy makers act preemptively to mitigate an otherwise-impending contraction.

Overcoming these identification challenges—and, thus, demonstrating the real effects of fiscal policy—contributes to our understanding of positive macroeconomics. Moreover, because several theoretical frameworks compete to explain the effects of government in the economy, these contributions afford macroeconomists opportunities to identify frameworks consistent with the empirical results, and to probe these frameworks for insight into how government may affect other essentially unobservable aspects of the economy, such as private welfare. For example, suppose empirical studies reveal that unannounced tax cuts stimulate employment and real gross domestic product. In one framework consistent with this fact, households choose optimal lifetime paths of consumption and leisure. A tax cut in this environment leaves consumers’ lifetime incomes unchanged, because a tax cut portends a subsequent tax hike (and because consumers can easily access credit). The tax cut leaves consumption largely unchanged and it may encourage working in the short run, when after-tax wages are relatively high. Thus, according to this framework, employment and output rise, even though private welfare may not.

Knowing how fiscal policy shapes and shifts near-term economic activity is important, of course; but, so too is knowing how fiscal policy shapes long-term government budgets and debt, monetary policy, politics, and institutions—all of which, in turn, shape future economic activity.

In Fiscal Policy After the Financial Crisis, leading macroeconomists investigate all of these outcomes. They focus on episodes of crisis and contraction; several proffer clever and, in some cases, now-familiar instrumental approaches to identify exogenous realizations of government spending and taxing; and all contribute important work of exceptional quality, delivered in ways that will appeal to policy makers, scholars, students, and generalists alike. Alberto Alesina and Francesco Giavazzi edited this comprehensive volume, a National Bureau of Economic Research (NBER) conference report of thirteen papers and discussant’s comments from an NBER conference in Milan in December 2011.

The volume opens with chapters on the fiscal multiplier and its effect on labor markets. How discretionary government spending shapes and shifts economic activity seems to depend, in part, on when and for whom we measure it. For example, based on US data spanning several decades, government spending lowers private spending and raises public-sector employment (Valerie A. Ramey); based on a large panel of Organization for Economic Co-operation and Development countries, government spending raises private spending and employment, but only in recessions (Alan J. Auerbach and Yuriy Gorodnichenko); and, based on household-level data, government spending lowers consumption spending in lower-income households and raises the number of hours part-time employees work (Francesco Giavazzi and Michael McMahon).

In any case, government spending can have dreadful, long-term consequences. Fiscal gaps between public assets and liabilities can grow large enough to provoke debt crises; according to one estimate, [End Page...