We investigate the macroeconomic effects of fiscal consolidations based upon government spending cuts, transfers cuts and tax hikes. We extend a narrative dataset of fiscal consolidations, with details on over 3500 measures for 16 OECD countries. We show that government spending cuts and cuts in transfers are much less harmful than tax hikes, despite the fact that nondistortionary transfers are not classified as spending. Standard New Keynesian models robustly match our results when fiscal shocks are persistent. Wealth effects on aggregate demand mitigate the impact of a persistent spending cut. Static distortions caused by persistent tax hikes cause larger shifts in aggregate supply under sticky prices.
The conventional wisdom is (i) that fiscal austerity was the main culprit for the recessions experienced by many countries, especially in Europe, since 2010 and (ii) that this round of fiscal consolidation was much more costly than past ones. The contribution of this paper is a clarification of the first point and, if not a clear rejection, at least it raises doubts on the second. In order to obtain these results we construct a new detailed “narrative” dataset which documents the size and composition of the fiscal plans implemented by several countries over 2009–13. Out of sample simulations, that project output growth conditional only upon the fiscal plans implemented since 2009, do reasonably well in predicting the total output fluctuations of the countries in our sample over the years 2010–13 and are also capable of explaining some of the cross-country heterogeneity in this variable. Fiscal adjustments based on cuts in spending appear to have been much less costly, in terms of output losses, than those based on tax increases. Our results, however, are mute on the question whether the countries we study did the right thing implementing fiscal austerity at the time they did, that is 2009–13.
Prepared for the 60th Economic Policy Panel, held on October 24-25, 2014 at EIEF in Rome. We thank Armando Miano and Giulia Giupponi for excellent research assistance. We are grateful to Refet Gurkaynak and two anonymous referees: their comments greatly improved the paper. We also thank Mario Buti, Vitor Constâncio, Paolo Mauro and the members of the Economic Policy Panel for their comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
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