How should a fiscal stimulus be designed?

In late 2008, the economic crisis forced the UK government to implement a fiscal stimulus. Prior to the Pre-Budget Report in December 2008, this research investigated three questions. Could the UK afford a fiscal stimulus? Would a fiscal stimulus be effective? And how should any such stimulus should be designed? The research indicated that the UK could afford a stimulus, and that it could be effective. It proposed that support should be targeted towards individuals, households and firms that were more likely to be credit-constrained, who would be more likely to spend any additional income generated from a stimulus package. This would have been achieved by, for example, an increase in child and working tax credits, and a temporary increase in capital allowances. In the event, the main stimulus was the temporary reduction in VAT, which was not well targeted – its most effective element was that it was temporary, encouraging spending to be brought forward from 2010 to 2009.

Michael Devereux, Clemens Fuest