What fiscal policy combinations has the federal government most often followed to stimulate economic activity when the economy is in a severe recession?

Answer 1

The ferderal government can only stimulate the economy by reducing taxes, intesify support of businesses or pumping money into public infrastructure ... or intervene in the central bank (FED).

Central banks have more efficient measures to stimulate.

They usually decrease the key interest rate to stimulate the economy and avoid a recession. Descreasing this interest rate will lead to lower interest rates on business loans and motivates business owners to invest. More investment stimulates the economy.

However, the key interest rate in the US is close to zero nowadays. The FED can no longer reduce it - negative key interest rates would be rubbish. Some economists call it the "zero interest trap". The FED ist now trying to stimulate the economy by buying most of the treasury bonds. Investors can no longer flight to bonds and are forced to invest in stocks and commodities. This MIGHT stimulate the economy as it increases the liquidity of the capital markets and could motivate investors to invest in businesses. - This is called quantitative easing (QE1, QE2).

Quantitative easing is a large scale experiment. It has never been proven effective. However, the economy will look healthy as investors cannot move out of the markets. The only choice they have is

• Invest in stocks (US or non-US)
• Invest in commodities
• real estate (2008 correction is still ongoing)
• Hold cash

If the economy does not recover it is likely that bubbles are built up, following a sharp correction on stock and/or commoditites. The end of quantitative easing (scheduled for end of june) could be a triggering event for a correction. We will see what the FED is going to do next.

I personally do not see any alternatives to a new QE round (QE3 or whatever it will be named).