When Should Short-Term Fiscal Stimulus Go Into Reverse?

If policy-makers use fiscal policy--that is, some mixture of government spending and tax cuts--to stimulate an economy in recession, at what point should this short-term  policy be reversed? Alan Auerbach and William Gale point out that over the last four U.S. recessions, the willingness to reverse short-term fiscal policy has diminished.

For example, in the deep recession of 1981-82, President Reagan had pushed for tax cuts in 1981. But in
August 1982, when the recession was not yet over,  Congress passed and Reagan signed the Tax Equity and Fiscal Responsibility Act (TEFRA), scaling back those tax cuts. Similarly, in the recession of 1990-91, the first President George Bush and Congressional leaders produced legislation aimed at reducing in October 1990--when the recession was still going on.


This pattern has changed, so that instead of acting to reduce looming deficits while the recession is still going on, the U.S. now continues its fiscal stimulus policies a couple of years into the recovery. For example, the recession that ended in November 2001 was followed by additional tax cuts in 2002 and 2003. Now, with a recession that ended two years ago in June 2009, there is still a widespread belief that it is "too soon" to undertake a serious effort to reduce the budget deficit.

I'm a reluctant and dour Keynesian who supports aggressive fiscal policy during a recession, especially a dire event like the Great Recession of 2007-2009 -- but who views such policies as only helping to ameliorate the pain of the recession itself. The arguments for continuing fiscal stimulus for several years after a recession has ended are much weaker. The Congressional Budget Office forecasts that the U.S. economy won't return to full employment until 2016. It seems unwise, to plan on eight consecutive years of fiscal stimulus, from when the recession became apparent in 2008 until the economy returns to full employment in 2016. In fact, global capital markets, looking at the projected rise in the debt/GDP ratio, may be unwilling to let the U.S. government borrow to pursue such a policy.