Fiscal policy and crowding out in developing Asia

Abstract

Fiscal stimulus programs have contributed substantially to developing Asia's faster and stronger than expected recovery from the global financial crisis. This may lead to political pressures for greater use of countercyclical fiscal policy in the postcrisis period. However, the countercyclical effectiveness of fiscal policy depends critically on the extent to which it crowds out private investment and consumption. In the medium term, the use of fiscal policy to promote rebalancing toward domestic demand may require a moderate fiscal expansion. The extent of crowding out will impinge upon the effectiveness of such fiscal expansion in boosting domestic demand. Therefore, crowding out has implications for the effectiveness of fiscal policy as a tool for both short-run macroeconomic stabilization and medium-to long-term structural rebalancing. Overall, our evidence is decidedly mixed, with no clear evidence of either crowding out or crowding in. The evidence fails to provide compelling support for greater use of fiscal policy for countercyclical purposes. In the context of rebalancing, fiscal expansion will not, in and of itself, contribute to a more balanced demand and output structure. That would require using fiscal policy to help remove the structural impediments to private consumption and investment. © 2010 by Asian Development Bank.