"Federal Reserve typically responds to downturns with prompt and large reductions in interest rates. Discretionary fiscal policy, in contrast, rarely reacts before the trough in economic activity, and even then the responses are usually small. Simulations using multipliers from both simple regressions and a large macroeconomic model show that the interest rate falls account for nearly all of the above-average growth that occurs early in recoveries. Our estimates also indicate that on several occasions expansionary policies have contributed substantially to above-normal growth outside of recoveries...
Our central conclusion is that monetary policy alone is a sufficiently powerful and flexible tool to end recessions... Discretionary fiscal policy, in contrast, does not appear to have had an important role in generating recoveries... Thus the historical record contradicts the view that fiscal policy is essential to ending recessions or ensuring strong recoveries... Policy-makers become overly concerned about the possibility of weak growth during expansions, or excessively optimistic concerning the prospects for expansion without triggering inflation, and therefore ... adopt excessively expansionary policies... However, in periods where policymakers have been concerned about low growth, they have often undertaken major fiscal expansions... On several occasions, such expansionary policies appear to have contributed substantially to above normal growth."
However, a closer scrutiny of this paper gives the impression that the takeways from this paper should be much more ambiguous and nuanced. For a start, the authors themsleves claim that monetary policy appeared more influential in economic recoveries "early in recoveries". This claim is understandable since it is based on the finding that Central Banks step in early and adequately with their rate cuts, whereas policy makers take time (often well past the trough) to cobble up a politically consensual fiscal policy which also often ends up being too little too late.
More importantly, the paper does not appear to make a substantive case that fiscal policy is less effective than monetary policy, assuming both to be initiated early and are adequately large enough. It also does not compare the costs/benefits (in monetary terms and in terms of reducing the extents - time and depth - of the crisis) associated with each response. In other words, the article is an empirical analysis of (as is) macroeconomic policy making (with all its flaws and deviations) during post-war recessions, and it may therefore be not fully appropriate to draw normative conclusions about the superiority or otherwise of specific policy choices.
It therefore compares the effects of effective (more likely) and swift monetary policy responses with flawed and delayed fiscal responses. The mere fact that monetary policy responses are easier to administer, which they are, does not in anyway make a conclusive case that it is always a superior macroeconomic policy option.
It also acknowledges the fact that on several occasions, expansionary policies have contributed substantially to above normal growth. The authors main concern with the efficacy of fiscal policies, that there is no means of knowing how much expansion is required and therefore there arises the strong possibility of over-shoot or under-shoot on the desired outcomes, would apply with almost the same measure to monetary policy responses too. I am personally inclined to believe that the appointment of Prof Christina Romer as the Chairperson of the Council of Economic Affairs in the Obama administration may have contributed to the salience of the article in the debate.
My favorite perspective of the debate comes from Prof Alan Blinder of Princeton. This is one of the best articles against the blanket critics of discretionary fiscal policy. His balanced conclusion throws some much needed clarity to the "black or white" debate,
"Under normal circumstances, monetary policy is a far better candidate for the stabilization job than fiscal policy. It should therefore take first chair... (and is) the conventional wisdom. That said, however, there will be occasional abnormal circumstances in which monetary policy can use a little help, or maybe a lot, in stimulating the economy—such as when recessions are extremely long and/or extremely deep, when nominal interest rates approach zero, or when significant weakness in aggregate demand arises abruptly. To be prepared for such contingencies, it makes sense to keep one or more fiscal policy vehicles tuned up and parked in the garage, and perhaps even to adopt institutional structures that make it easier to pull them out and take them for a spin when needed."
And, the present circumstances are not only abnormal, but exceptionally so, and therefore the importance of expansionary fiscal policy becomes ever more magnified. Daniel Gross has a neat summary of the debate, and pumps for the "all of the above" answer instead of an "either-or" one!
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