One of the lessons of the Great Recession is that monetary policy alone isn't enough to offset the effects of a massive economic downturn. Pushing the Federal Reserve's target interest rate as low as it can go, as monetary policy authorities did early in the recession, helped limit its severity.
But once interest rates are near zero, the Fed's power to stimulate the economy diminishes considerably. That means the Fed cannot, by itself, offset and overcome the forces pushing the economy into a severe recession. To accomplish that goal, fiscal policy also has to play a role.
Attempts to use fiscal policy, however, run into a big stumbling block: objections to the large increases in the deficit that come with tax cuts or additional government spending needed to stimulate the economy.
Even though the economics of large deficit increases to finance, say, infrastructure construction are supportive (worries that an increase in the national debt will cause interest rate spikes or other problems appear to be unfounded), the political will needed to pursue deficit spending on infrastructure or anything else simply isn't there.
But one message that did not come through very strongly in public discussions of economic policy during the Great Recession is that stimulative fiscal policy doesn't necessarily require an increase in the deficit. The most powerful forms of fiscal policy do involve increases in the deficit, but the government has ways to provide a considerable boost to the economy without raising the deficit at all.
The first is known as the balanced-budget multiplier. Under this policy, new spending is financed in full by raising taxes. How, you might ask, can taking a dollar away through taxation and then spending that dollar on infrastructure stimulate the economy? Hasn't the government taken away an amount equal to what was added?
The answer is that part of the taxes will be paid by reducing saving rather than consumption, and this will have a net positive impact on the economy.
Suppose, for example, that on average 33 cents of every dollar is saved. If taxes go up by a dollar, this means consumption will go down by 67 cents and saving will go down by 33 cents. If the dollar is used to finance new government spending, then the net impact on aggregate demand will be the $1 in new spending minus the 67 cents in lost consumption.
So, there's a net positive impact on aggregate demand of 33 cents. In recessions, savings sit idle because investment opportunities diminish considerably, which essentially allows this policy to put some of the idle savings to work.
There are also Keynesian multiplier effects associated with this new spending, and macroeconomic theory tells us that when these effects are fully realized, the balanced-budget multiplier is one. That is, when multiplier effects are included, a dollar of new spending financed by raising taxes by a dollar will have a $1 effect on aggregate demand and output.
So, if we're willing to raise taxes and use the new revenue to finance new government spending, it's possible to give the economy a substantial boost.
The second way to stimulate growth without creating new government debt is through income redistribution. The amount that households save depends on household income. When income is low, saving is also low, often nonexistent or negative (i.e. they are net borrowers). But when income is high, the amount of income that is saved is much, much higher.
One study by the San Francisco Fed estimates that households at the upper end of the income distribution save about one-third of any additional income they receive, while those at the bottom have zero or negative saving. Thus, in a severe recession when saving isn't being turned into productive investment, one-third of the income of the wealthy sits idle, doing nothing to help to stimulate the economy.
If we could somehow put that idle savings to work, it would have a fairly large impact on aggregate demand. One way to do this is to use the tax system to temporarily reduce taxes on lower-income households and offset it completely by raising taxes on the wealthy. The effect of this is to take a dollar from the rich and give it to the poor, and increase overall spending by about a third. Because the poor do not save one-third of their income as the rich do, overall consumption will increase.
Of course, even though these polices avoid the political problem of raising the deficit because they're deficit-neutral, they come with their own political problems. Both policies require an increase in taxes. In the second case, the new taxes necessarily fall on the wealthy, and in the first case the wealthy are likely to shoulder most of the burden.
The political power the wealthy enjoy would make policies like these a very difficult sell in Congress, but it's important to realize that the objections are political, not economic.
So, yes, we can stimulate the economy without changing the government debt at all, and such polices would impose the largest burden on those who are most able to absorb it, the wealthy. But what's missing is the political will needed to implement these policies -- the willingness of those who have the most to help those who are struggling the most in bad economic times.