Fiscal Policy and Growth

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Whilst many central banks have clear macroeconomic objectives, it is not obvious that fiscal authorities solve any. Aside from ensuring solvency and providing some automatic stabilisers (Leeper, 2016), there is little evidence to suggest that government policies are designed with growth as its primary goal.This project, funded by ESRC, has fiscal policy and growth at its core. It comes as a new wave of research looks at the role of government in stimulating growth when monetary policy runs into severe diminishing marginal returns. Specifically, the goal is to gain a better understanding of the extent to which fiscal policies can affect growth, in the short- and long-run, in a period of secular stagnation.Secular stagnation refers to an era of low real interest rates and protracted spells of low growth with no force towards their recovery. It occurs when the natural real interest rate, the rate that balances the supply of savings and demand for investment at full employment, is sufficiently low that it cannot be achieved through conventional monetary policy. This may happen when a set of forces consistently push up the marginal propensity to save (MPS) or push down the marginal propensity to consume (MPC). Hypothetically, there are various mechanisms that could influence these marginal propensities and hence the natural rate. Domestically, if one agrees with Keynes, greater wealth disparities put more money in the hands of those more likely to save it. An ageing population creates a culture of conservative spending habits. Cheaper capital, resulting from technological advancements, means less monetary investment for businesses. On a country-wide scale, more international financial risk increases global uncertainty. The resulting self-insurance in developed countries, often in the form of foreign government reserves, alongside persistent trade surpluses in developing countries, creates a savings glut. Also, stricter financial regulations, which have the by-product of making it more difficult to borrow, reduce a countries' ability to spend. This is not an exhaustive list of potential mechanisms affecting the natural real interest rate. However, if we conjecture that many economies are currently in a period of secular stagnation, remedying some of these may lead to persistently higher growth. The preliminary aims of the research are, therefore, to (a) determine whether any of the mechanisms above can lead to permanently lower growth and (b), determine whether policies that remedy these mechanisms can create either temporary or permanent relief to low growth.Currently, I have spent time looking at the impact of fiscal redistribution on growth. Fiscal redistribution refers to policies that reduce income disparities within countries. Using the Standardised World Income Inequality Database, which provides comparable data on inequality and redistribution for 196 countries between 1960-2017, I obtained two key results. Firstly, fiscal redistribution is pro-growth. This effect is greater for countries who currently redistribute less and also for countries who are more unequal. Secondly, inequality is growth-retarding. Following a similar convexity argument, inequality hurts growth more when inequality is already high.Although the policy implications of this research are limited, the results do allude to the fact that, in certain scenarios, targeted government policy responses may have a role to play in generating growth. This could be particularly valuable during periods of low growth and when monetary policy cannot provide satisfactory impetus. The next step in journey is to ask whether; (i) fiscal policy is more growth enhancing when growth is low? And (ii), is this effect more likely to be permanent when growth is low? Regardless of type of policy analyzed, these will be two key question to answer for the duration of my PhD research.