One of the most prominent topics of recent political debate has been how best to return the US economy back to full employment.  Some argue that fiscal austerity is key in fostering recovery.  Others argue that increased government spending will spur growth in the private sector.  So which is it?  Should the government be cutting back or increasing its spending?









Keynesian economics suggests that while the economy is in a liquidity trap fiscal policy will be more effective at increasing GDP.  Ordinarily the Federal Reserve can influence the amount of economic activity by adjusting interest rates however in a liquidity trap the Federal Reserve has essentially cut interest rates to zero.  Even so investors are still unwilling to use the full productive capacity of the economy.  When this happens we see businesses closed and workers unable to find jobs.

I have been working with Micheal Cordoso and Emilee Fragapane on an analysis of the new data available since the recession to see if Keynesian economics still holds true.  More specifically we are looking to see if the fiscal multiplier increases while the economy is in a liquidity trap.  Does US fiscal policy get a greater bang for its buck while the economy is in a liquidity trap?  I don't want to spoil the ending but our research, along with most other recent research, suggests this is the case.  This indicates we should be using fiscal policy more aggressively until we exit the liquidity trap and return the economy to full employment.

If you are interested in the details you can check out our research here:

New Evidence For The Use Of Fiscal Policy In A Liquidity Trap