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spells. Because the resulting unemployment dynamics depend on the path
of unemployment, not just on its current level, this phenomenon is often
referred to as “hysteresis” in the rate of unemployment.
The potential for hysteresis in unemployment—the economy getting
stuck at high rates of unemployment for an extended period—provides a
further argument for activist fiscal policy, and models that build in hysteresis
effects can have large and sustained multipliers (see for example Phelps
1972, Blanchard and Summers 1986, Ball 2009, and DeLong and Summers
2012). Reifschneider, Wascher, and Wilcox (2013) stress the relevance
of these channels to the current recovery. Their research shows that the
financial crisis damaged the productive capacity of the economy, by causing
a steep decline in capital accumulation, lower productivity growth, and
structural damages to the labor market, and a large portion of this damage to
the productive capacity stemmed from weak demand. These results suggest
that under such conditions fiscal policy can continue to have a meaningful
effect on output with a substantial lag.
This recent work has moved far beyond the basic multiplier. It shows
that fiscal and monetary policy can influence each other in substantial ways.
While fiscal multipliers might be less than the basic model suggests in mild
recessions and when monetary policy is unconstrained, they can be large
when monetary policy is at the zero lower bound. In addition, fiscal expansion
in a deep recession can have additional long-term benefits, and therefore
high multipliers, by shortening spells of unemployment, minimizing the
erosion of human capital, and increasing future productivity.
Time Series Evidence
Evaluations of fiscal effects using the structural models described
above reflect the economic theory used to construct the models. The reliability
of the resulting estimates therefore depends on the reliability of the
underlying macroeconomic theory. A complementary approach to evaluating
the effects of fiscal policy is instead to use models that rely less on economic
theory and more on historical empirical evidence.
The main challenge to credibly implementing this data-driven
approach is using just enough theory, or finding enough independent variation
in the data, to estimate the causal effect of fiscal policy on the economy:
simply noting that two variables move together does not establish causality.
For example, if Congress passed countercyclical fiscal policy whenever
a recession loomed, a figure plotting the countercyclical policy variable
and GDP growth would show that countercyclical policy occurred at the
beginning of recessions. An analyst might conclude, incorrectly, that this
policy caused the recession, when in fact the policy was itself caused by the
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