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The valuation of economic recovery: The case for investment-led fiscal spending policies in open economies

Author

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  • García, Carlos J.
  • González, Wildo
  • Valenzuela, Gabriel

Abstract

We show quantitatively that an expansionary fiscal policy that takes into account future debt can be a valid tool to stabilize open economies subject to rare but severe shocks in a context of flexible exchange rates and capital flows. We assume that fiscal spending is directed towards investment to boost private spending, and that neoclassical preferences are replaced by preferences in which households also value economic recovery after a severe shock (preferences based on learning experience). Taken together, these seemingly unrelated conditions allow expansionary fiscal policy to induce a genuine recovery in the economy and to outperform some cases of expansionary monetary policy in terms of welfare. The mechanism is simple: investment-oriented fiscal spending, which ensures a faster recovery, is valued by households and thus stimulates consumption in a virtuous circle. Thus, a faster recovery based on investment-oriented fiscal spending is preferable to targets such as inflation and/or debt, which can still be maintained, but to preserve long-term stability.

Suggested Citation

  • García, Carlos J. & González, Wildo & Valenzuela, Gabriel, 2025. "The valuation of economic recovery: The case for investment-led fiscal spending policies in open economies," International Review of Economics & Finance, Elsevier, vol. 99(C).
    • Handle: RePEc:eee:reveco:v:99:y:2025:i:c:s1059056025001765
    DOI: 10.1016/j.iref.2025.104013
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    More about this item

    Keywords

    The GHH preferences; Government spending; Crowding-out effect; Open economies; Exchange rate; Severe External shocks; Stabilization policies; Learning-based experience preferences; Subsidies and public investment;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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