Balcerowicz, Leszek

Rzonca, Andrzej

Policy Documentation Center

       10/2008                                December 2008   
www.case-research.eu
CASE Network E-briefs
As the financial crisis continues to attack the global 
economy, there is increased pressure on governments 
around the world to introduce discretionary fiscal stimulus 
programs.  Up until now, we have observed massive 
interventions in the financial sector, massive easing of 
monetary policy, especially in the US, and the allowance of 
automatic stabilizers to produce a very substantial easing 
of fiscal policy.  A discretionary fiscal stimulus program 
has just been enacted in the UK.  In the US, a growing 
number of policymakers are proposing larger and larger 
stimulus packages, while the European Union is debating 
its own future fiscal stimulus program.  Additionally, the 
IMF has just called for additional fiscal stimulus programs. 
Even Japan, with a public debt exceeding 170% of GDP, is 
urged to engage in fiscal activism. 
Diverging views of success 
The assumption appears to be that discretionary fiscal 
stimulus will automatically revive private spending. But 
this belief contrasts with an extensive empirical literature 
showing there is a considerable uncertainty about the size 
and even the sign of fiscal multipliers1.
1  For a recent useful review of the literature, see the International 
Monetary Fund, World Economic Outlook, October 2008. 
Some say that monetary policy in the US, given its low 
interest rates, is no longer an effective policy tool and that 
only a fiscal stimulus can revive the economy.  Similarly, 
in the 1990’s and early 2000’s Japan had interest rates 
that were just as low as or even lower than US rates. 
Interestingly, some prominent proponents of current fiscal 
stimulus programs acknowledged that past expansionary 
fiscal policies did not always bring the desired economic 
outcomes.  
Others believe that a financial crisis in developed 
economies has created favorable conditions for strong 
Keynesian multipliers to operate, with no crowding out 
effects and no confidence problems among consumers. 
According to this school of thought, a discretionary fiscal 
stimulus would boost consumers’ confidence and increase 
their readiness to spend the extra money.  It is believed 
that the larger the stimulus, the stronger its impact on this 
confidence and, therefore, the size of fiscal multipliers. 
But in what ways this fortunate effect will be produced is 
left unexplained.  Instead of a strong empirical basis for 
this very important proposal, mechanical metaphors, such 
as “jump-starting” the economy, are often employed.
Impact on consumer spending and economic recovery
Common sense and massive research tells us that 
consumers should not be regarded as Pavlov’s dogs, 
automatically responding to current stimuli offered 
to them by politicians.  Consumers are human beings 
guided by expectations.  They have a longer term view 
in mind when making their current spending and savings 
decisions.  This perspective limits the stimulating effect of 
most temporary tax cuts relative to permanent ones.
In their assessment of disposable income on a longer 
term basis, consumers also have concerns about fiscal 
sustainability.  Substantial empirical literature suggests 
that when the public debt to GDP ratio is already high, fiscal 
multipliers are very low.  In extreme cases, fiscal expansion 
may even be contractionary.  This fact should help to 
reduce the number of countries tempted to initiate fiscal 
stimulus programs, especially taking into consideration 
their unfunded liabilities and the fiscal consequences 
of public interventions undertaken thus far.  Not only is 
there a danger that the high initial level of public debt 
A Non-Stimulating Stimulus?
By Leszek Balcerowicz and Andrzej Rzońca
Source: IMF, World Economic Outlook, October 2008
       10/2008                                December 2008   
www.case-research.eu
relative to GDP will limit the impact of any fiscal stimulus, 
but that the sheer size of a stimulus package, which would 
be proportionate to the deterioration of a country’s fiscal 
position, may adversely affect consumers’ confidence.  
Consider the developments in Sweden during the early 
1990’s, a period of very deep banking crisis. From 1990 
until 1994, the primary balance of general government 
spending in Sweden deteriorated by 14.1% of GDP.  Less 
than one fourth of the fiscal deterioration could be 
attributed to cyclical factors.  Discretionary fiscal stimulus 
was immense, but counter-productive. With public debt 
growing fast, households and entrepreneurs became very 
pessimistic about the economic future of the country. 
Their pessimism pulled private spending down which 
was deepened to some extent by an increase in interest 
rates. The risk premium rose to the same level as in Italy, 
a country with a long tradition of excessively loose fiscal 
policy2.  This is a warning that easy and cheap financing 
of radically increased budget deficits should not be taken 
for granted.  
Impact on financial markets 
 
The current crisis has taught consumers in many countries 
that there are limits to one’s personal debt level.  Should 
these consumers apply the same lessons to their country’s 
public debt, especially once they are made aware of the 
potential costs associated with a fiscal response to the 
crisis in the financial sector?
A large fiscal stimulus may in fact turn out to produce a 
negative impact upon financial intermediation. Financial 
turbulence generates the risk of a credit crunch. Effective 
ways to mitigate this danger is a major concern for 
many governments. One of the major reasons for banks’ 
reluctance to lend is their lack of sufficient capital. 
According to the IMF’s recent Global Financial Stability 
Report, banks need globally close to $700 billion of 
additional capital.  Were governments to simultaneously 
accrue their borrowings in order to finance their fiscal 
stimulus, banks would have to work harder to gain access 
to global capital markets, with the result of potentially 
limiting any further increases in their capital and lending 
capabilities.  The ability of the emerging economies to 
finance their growth would be strongly altered too. 
2  Giavazzi F. and Pagano M., Non-Keynesian Effects of Fiscal Policy 
Changes: International Evidence and the Swedish Experience, 
Swedish Economic Policy Review, vol. 3, no. 1, Spring 1996, pp. 
67-103.
Lastly, an increase in the supply of governments’ securities 
could restrict the banks’ private sector lending activities. 
Such a swelling of the “crowding out” effect has in past 
recessions particularly affected less developed economies 
with limited financial markets. The present crisis is 
likely to reduce the size of these markets in developed 
countries as well.  Thus one can hardly rule out similar 
outcomes occuring in these countries.  Furthermore, an 
improvement in the quality of assets portfolio of banks 
due to an increased share of government securities could 
weaken banks’ incentives to deal with inherited bad assets 
and heighten political pressures put on banks to lend to 
large enterprises that are considered too big to fail. 
Future Challenges
Contrary to Keynes’ famous dictum, the long run should 
not be forgotten.  One thing is sure: a large fiscal stimulus 
would considerably increase public indebtedness, 
imposing a burden on future growth.  Moreover, large 
increases in public investment spending are likely to be 
wasteful, as it is not possible to have a comprehensive 
backlog of well prepared projects.  As a result, political 
pressures may dominate efficiency considerations. 
Under certain conditions a buildup in spending may 
also raise the likelihood of corruption. Such worries 
were recently reported in China.  A fiscal stimulus that 
temporarily lowers indirect taxes at the cost of future 
increases in marginal income taxes (for example, in the UK) 
does not improve the most precious aspect of the supply 
side, i.e., the incentives to work, invest and innovate.
To sum up, the stimulating effects of large fiscal stimulus 
programs in most countries are likely to be disappointing, 
while the longer term effects would be rather negative. 
The present financial crisis is blamed, among other things, 
on deficient risk management. The proposals for a large 
fiscal stimulus may suffer from the same weaknesses. 
Mr. Balcerowicz, a former Finance Minister, Deputy Prime 
Minister and Central Bank President in Poland, is Head of 
the International and Comparative Studies Department 
at the Warsaw School of Economics, visiting fellow at 
the Peterson Institute for International Economics and 
member of the CASE Supervisory Council.  Mr. Rzonca 
is an adjunct professor of economics at the Warsaw 
School of Economics and the Chief Economist of the FOR 
Foundation.
This e-brief is based on an article that was written by the 
authors and published in the December 10th edition of the 
Financial Times. 
The opinions expressed in this publication are solely the authors’; they do not necessarily reflect the views of CASE - Center for Social and 
Economic Research, nor any of its partner organizations in the CASE Network.  CASE E-Brief Editor: Ewa Błaszczynska


E-briefs No. 10/2008: A non-stimulating stimulus?

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