Recently, as Congress considers policies to foster economic growth, arguments have been made that some traditional expectations of fiscal policy should be revisited, namely that cutting spending will contract the economy in the short run. Proponents of this view also argue that cutting spending rather than raising taxes would be a more effective means of increasing economic growth. These arguments often refer to recent empirical studies of deficit reductions across countries. This view contrasts with that held by most economists, which will be referred to as "mainstream economics." Chairman Bernanke of the Federal Reserve was referring to this view when he cautioned against large and immediate spending cuts. Just as economists generally consider spending cuts to be contractionary in the short run in an underemployed economy, they believe that deficits can be harmful in the long run by crowding out private investment. There is widespread agreement that the continuation of current tax and spending policies will lead to an unsustainable path of the national debt. The fundamental cause of these long-run problems predates the Great Recession and the increase in debt relative to GDP from that recession, and arises from the aging of the population and the growth in health care costs. Thus, to most economists, the policy challenge is a trade-off between the benefits of starting to address the debt problem earlier versus risking damage to a still-fragile economy by engaging in contractionary fiscal policy, or failure to continue with expansionary fiscal policy. Most economists have both neoclassical and Keynesian-style views, one applied largely to questions of microeconomics and the other to questions of macroeconomics. Consistent with the theory above, the spending multipliers in this model are larger than tax cut multipliers. The International Monetary Fund (IMF) Study

The IMF study examines the same types of contractions as those in the Alesina and Ardagna study, but with a different methodology. They find that spending cuts are less contractionary than tax increases, but attribute this effect in part to the greater offsetting monetary stimulus. Applicability of the Empirical Evidence in Alesina and Ardagna to Current U.S. The major determinant of the effects on growth is the magnitude of deficit and debt reductions. Conclusion

The claim based on the evidence of Alesina and Ardagna (and similar studies) that policies traditionally viewed as contractionary, such as cutting spending, will increase growth in the short run in the United States, can be questioned on at least two grounds. Second, the deficit reductions in the Alesina and Ardagna study that were successful by the authors' measures were associated with economies generally above, or close to, full employment in most cases. Reducing the deficit while the economy is still fragile and well below full employment would likely involve further contraction that might not be desirable.
As Congress considers policies to foster economic growth, arguments have been made that the traditional expectations of fiscal policy, namely that cutting spending will contract the economy in the short run, should be reversed. Proponents of this view also argue that cutting spending rather than raising taxes would be a more effective means of increasing economic growth (or at least avoiding contractions). These arguments often refer to recent empirical studies of deficit reductions across countries.
This view contrasts with that held by most economists and found in conventional models. In those models cutting spending will contract the economy. Chairman Bernanke of the Federal Reserve was referring to this view when he cautioned against large and immediate spending cuts. Most multipliers (measures of the effect of deficits on the economy) indicate that spending cuts contract the economy more than do similarly sized tax increases.
Just as economists generally consider spending cuts to be contractionary in the short run in an underemployed economy, they believe that deficits can be harmful in the long run by crowding out private investment. There is considerable agreement that the continuation of current tax and spending policies will lead to an unsustainable path of the national debt, largely because of the growth of mandates arising from the aging of the population and the growth in health care costs. Thus, to most economists current macroeconomic policy challenges involve a trade-off between the benefits of starting to address the debt problem earlier versus risking damage to a still-fragile economy by engaging in contractionary fiscal policy, or failure to continue with expansionary fiscal policy.
Alesina and Ardagna, in the study perhaps most commonly cited to support the view that cutting spending will not be contractionary, find that historical episodes across 21 countries when debt reduction was associated with growth used spending cuts rather than tax increases. Other studies that largely perform the same analysis find similar results. This research has been interpreted as suggesting that spending cuts are superior to tax increases and that such cuts would not necessarily contract the economy. Proponents of this view, to support these empirical findings with theory, argue that deficit reduction will increase confidence of consumers and business, resulting in increased current spending on consumption and investment.
The International Monetary Fund, however, correcting problems they perceived in the Alesina and Ardagna study, found spending cuts to be contractionary, consistent with mainstream views. Moreover, while the IMF found cuts in spending to have smaller effects than tax increases, those effects were generally ascribed to offsetting monetary policy which was more significant with spending cuts than tax increases.
The findings in the Alesina and Ardagna study that successful debt reductions were associated with higher growth when spending cuts were used was based on 9 observations out of 107 instances of deficit reduction, or less than 10% of the sample. In addition, most of the countries where debt reductions were successful were at or close to full employment, while the United States remains well below full employment, raising questions as to whether this evidence is applicable to current U.S. conditions. Thus, both methodological questions and questions of applicability to current circumstances can be raised for the Alesina and Ardagna, and similar, studies.