Over at WaPo, wherein I argue that a) when we hit the next recession, many policy makers will point to our higher-than-average debt/GDP ratio as evidence that we have too little fiscal space to engage in offset fiscal stimulus, and b) those policy makers will be wrong.
I cite an important new paper by Romer/Romer on these points, showing that when you show up to put out a fire, you’d better bring some water. IE, countries with more fiscal and monetary space do more to offset negative shocks than countries with less space.
But the other very important, recent piece in this space is Auerbach/Gorodnichenko’s empirical work on how we have more fiscal space than is typically realized. If you want an excellent summary of their findings, see Furman’s comments on it, e.g.:
The key result in the Auerbach and Gorodnichenko paper is that a fiscal expansion in an economy with a substantial output gap is likely to lower the debt-to-GDP ratio because it raises the numerator (debt) by less than it raises the denominator (GDP). Relatedly, they find that in these circumstances there is more evidence for fiscal expansions resulting in lower real interest rates and Credit Default Swap (CDS) on sovereign debt, market developments that are consistent with the improved fiscal sustainability. Moreover, they find no evidence that fiscal expansion is less effective in a high-debt economy. Critically, all of these results are about economies in downturns—their featured point estimate for the impact of a fiscal expansion in an expanding economy is that it would increase the debt-to-GDP ratio.
Why the Hamlet reference? As the erudite OTE crowd knows, he said, “…there’s nothing either good or bad, but thinking makes it so.” What you didn’t know is that he was talking about fiscal space at high debt/GDP ratios.