The consequences of fiscal stimulus on public debt: A historical perspective

Abstract

The current policy agenda of neoclassical macroeconomics, as expressed within conservative political circles in the UK and European Union, is that fiscal contraction is the lever that can bring about recovery from the current economic downturn. Allegedly, the reason is that when business sees that the government balance sheet is improving-and public debt declining-there will be greater confidence in the country's economic prospects, and this increased confidence will lead to higher investment. This in turn will lead to growth and the road to economic recovery. This study examines the impact of government stance on public debt for 11 OECD countries for which data on the relevant factors are available from 1881 to 2011. Contrary to traditional predictions, it turns out that over this long historical span, fiscal contractions deteriorated rather than improved public debt as a percentage of GDP. This implies that fiscal austerity exacerbates the lack of demand and deteriorates rather than enhances the prospects of economic recovery.