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Prior to the global financial crisis (GFC) of 2007-2008, studying the effects of fiscal policy on real economic variables like output and employment had fallen out of fashion in macroeconomics.^[1] This was largely because monetary policy was viewed—since Paul Volcker’s 1980s tenure as Federal Reserve Chairman—as the superior policy tool to regulate business cycles, being quicker, more targeted and completely transparent.

Since the GFC, we have seen numerous studies of fiscal policy and of a specific measure of interest—the so-called fiscal multiplier.^[2] A fiscal multiplier measures the response of economic variables to the shock of a one-time increase in government spending (holding, in principle, everything else constant). Research has shown that deficit-financed fiscal policy is stimulative when: (A) economic growth is below its potential and idle resources are available, and (B) the policy alters intertemporal decision-making by individuals and firms, pulling future consumption and investment into the present. Otherwise, deficit-financed fiscal spending crowds out private investment through higher interest rates as the government borrows from private capital markets.

Consider this about the U.S. economy: Unemployment is low, real wages are rising and inflation expectations are trending up. Add to this a growing skills mismatch that has resulted in worker shortages in certain sectors, especially in tech, all of which suggest that there is not much of an output gap.

Since the U.S. election in November, there has been much talk regarding federal infrastructure spending. At present, this spending's scope and scale remain undefined. It may take the form of direct government spending on infrastructure projects, but (A) above may not be true. Or it may take the form of tax incentives to create public-private partnerships, which might not result in (B) above. In other words, setting aside long-run ramifications of improving the condition of U.S. roads and bridges, infrastructure spending may not be particularly stimulative. It may simply push up interest rates. While actual policy is worked out in Washington, D.C., we should perhaps take the time to review "Evaluating the Fiscal Stimulus," circulated in 2009 by University of Chicago economist Kevin Murphy.