Scarring effects of major economic downturns: The role of fiscal policy and government investment
Abstract
. Long shunned as slow and ill timed, the response to the Covid-19 pandemic initiated a reas
sessment of fiscal policy as stabilisation tool. At the same time, there is ample evidence that major
economic downturns produce lasting effects on real GDP in spite of active fiscal policy in
terventions. This paper takes a fresh look at economic scarring in 26 OECD countries, including
14 EU member states, since 1970 and examines the role played by fiscal policy. We find that
higher current expenditure – the favoured active response - does not mitigate the lasting impact of
major economic downturns on real GDP. In contrast, more government investment can help but
generally receives little attention. As a result, scarring effects are significant confronting gov
ernments with sustainability risks, which in turn weigh on the room for manoeuvre in subsequent
downturns. In sum, fiscal policy makers face two difficulties in the event of a major economic
downturn: (i) adopt the right type of fiscal expansion, and (ii) find the right time to pivot from
short-term stabilisation to fiscal consolidation while protecting investment. Both challenges are
fraught with political economy issues.
Scarring effects of major economic downturns: The role of fiscal policy and government investment
Tipo de Actividad
Artículos en revistasISSN
0176-2680Palabras Clave
.Scarring effects Major economic downturn Fiscal policy Fiscal stabilisation