'Serious discussion offiscal policy has almost disappeared'
• Robert M. Solow (2002)
There was once a time when fiscal policy was considered the policy of choice for macro-stability. Monetary policy, some thought, was not a particularly useful tool (Blinder, 2004). During the 'golden' period of the 1930's to the 1960's, Keynesian theory was rife in the world of economics and fiscal policy could not be disputed as inappropriate at addressing macro-instability. Flash forward to the early 2000's and any talk of fiscal policy was all but neglected, some debates flared up here and there in theoretical discussions between Keynesians and Non-Keynesians. The role for macroeconomic stability however was by and large placed at the hands of central bankers. Imagine then the surprise among Neoclassical economists when, during the Global Financial Crises, many governments once again returned to the theory of Keynes's and implemented aggressive fiscal stimulus measures. China was one of the most notable nations to implement massive fiscal stimulus measures which some argue allowed the growing nation to weather the storm relatively better off compared to other nations.
What has been the recent development in the Keynesian versus Non-Keynesian debate on fiscal policy? Why do some economists insist that fiscal policy is not an appropriate tool to stabilize the macro-economy? What has been the effect of fiscal policy in China? This thesis seeks to address the relevance of fiscal policy in current contemporary discussions. It provides an overview into the practical and theoretical discussions on the use of fiscal policy as well as summarizes the current empirical literature on the effects of fiscal policy. Furthermore, an empirical examination is applied on China to estimate the effect that fiscal policy has had on output and private consumption.
'This thesis finds that fiscal policy in China has had quite a substantial impact on output. With the magnitude of the effect increasing as the change in government spending becomes larger. The findings from this thesis suggest that fiscal policy does in fact still have some role to play in macro-economic stability.