How government spending can be an effective way to escape recessions: Pompeo Pontone’s point of view

Quoting a work published by Regis Barnichon, Davide Debortoli, and Christian Matthes on “Economic Letter” (Federal Reserve Bank of San Francisco), “A key to designing fiscal policy‧‧‧

Quoting a work published by Regis Barnichon, Davide Debortoli, and Christian Matthes on “Economic Letter” (Federal Reserve Bank of San Francisco), “A key to designing fiscal policy is understanding how government purchases affect economic output overall. Research suggests that expanding government spending is not very effective at stimulating an economy in normal times. However, in deep downturns when monetary policy is constrained at the zero lower bound, public spending is more potent and can become an effective way to escape a recession”. But how can and should governments respond to deep recessions in order to stimulate the economy? This is the issue addressed by Professional Investment Specialist Pompeo Pontone in a recent intervention, which analyses the matter also in the light of the crisis brought on by the Covid-19 pandemic.
“As showed by Barnichon, Debortoli, and Matthes in their recent work (2020), the direction of the fiscal intervention is an important determinant of the spending multiplier”, explained the expert, adding that the spending multiplier is “above 1 associated with a decrease in public spending and substantially below 1 associated with an increase in public spending”.
As underlined in the work published on the FRB San Francisco’s website, during the Covid-19 pandemic, fiscal and monetary authorities have taken extraordinary measures to prevent spillover effects deriving from the temporary shutdown of businesses and, as a consequence of this, the potential lower overall demand in the economy. To ensure a rapid rebound of the latter, a popular fiscal tool is to use government purchases to stimulate aggregate demand.
In that regard, Pompeo Pontone pointed out that the effects of public spending play a crucial role in such a context: “The key here is to understand the asymmetric effects of public spending. If we take this asymmetry into account, it is crucial to model the Aggregate Supply function as a convex one, which will lead to an asymmetric multiplier”, he said. The expert continued his intervention by explaining that “government purchases could be an effective way to stimulate an economy during a deep recession when monetary policy is constrained at the zero-lower bound” and, he concluded, “this is consistent with the recent evidence that the spending multiplier can be above 1.5 when monetary policy is held fixed”.

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    As an Investment Consultant and Specialist, Pompeo Pontone is a Professional Investor with 25 years’ experience in the fields of Investment Management, Quantitative Finance & Derivatives Trading and Data Science.

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