Macroeconomic Effects of Fiscal Consolidation in Emerging Economies: New Narrative Evidence from Latin America and the Caribbean

Abstract

We estimate the effects of fiscal consolidation on economic activity based on a new narrative data set for 14 emerging economies in Latin America and the Caribbean (LAC). Following a Romer and Romer identification approach, we examine contemporaneous policy documents to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to the economic cycle. We find that a fiscal consolidation of 1% of GDP reduces real GDP by, on average, 0.9% in two years. The estimated effects are close to those we find for advanced economies based on a comparable narrative data set. We also find a strong “twin deficits” relation in LAC, with fiscal consolidation triggering an adjustment of the current account balance and depreciation of the real exchange rate that are more pronounced than in advanced economies.

Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design

“…In fact, based on the rational expectations theory, the contractionary effects of fiscal retrenchment would be more than offset by factors such as favorable market sentiment, especially when a consolidation was needed to achieve macroeconomic stability and a credible commitment to fiscal adjustment was able to boost private sector confidence and investment, which would result in a wealth effect on consumption and lower interest rates (Segura-Ubiergo, Simone, and Gupta, 2006 on transition economies; Gupta et al, 2003 and2005 on EMs andLICs;Giavazzi and Pagano, 1990;Afonso, 2010;Ardagna, 2010 and2013 on AEs). The empirical evidence on expansionary consolidation using ex-post cyclical adjustment methods to identify consolidation episodes has been challenged with more accurate methodologies used to estimate discretionary changes in fiscal policy based primarily on the narrative approach (Guajardo, Leigh, and Pescatori, 2014;and Carrière-Swallow, David, and Leigh, 2021). 9 However, more recent work still finds that expenditure-based consolidations could be expansionary under certain circumstances, such as in economies that are very open to trade or in those that start consolidation with high debt levels (exceeding 60 percent of GDP) and increased interest rate risk premiums (Ilzetzki, Mendoza, and Végh, 2013;and IMF, 2008).…”

“…By reducing aggregate demand, consolidation alleviates inflationary pressures. Carrière-Swallow, David, and Leigh (2021) document examples of countries who pursued improvements in CAPB to reduce inflation and stabilize reserves.…”

“…International institutions such as the IMF and OECD undertake periodic reviews and ad hoc studies of fiscal consolidation issues to guide their operational work (OECD, 2010(OECD, , 2012(OECD, and 2013IMF, 2014a;Eyraud and Weber, 2013;IMF, 2010a;IMF, 2010b, andDaniel et al, 2006), but there has been no comprehensive update in recent years. There are also streams of research focusing on specific issues related to fiscal consolidations, such as fiscal multipliers (Auerbach and Gorodnichenko, 2012;Ilzetzki, Mendoza, and Végh, 2013) and their economic impact (Carrière-Swallow, David, and Leigh, 2021;Guajardo, Leigh, Pescatori, 2014). Moreover, the global economic landscape has changed substantially since the Global Financial Crisis, which prompted an increase in the research on fiscal consolidation issues focusing initially on AEs.…”

Перспективы Развития Мировой Экономики, Апрель 2023 Года

“…Затем оценивается влияние описательных шоков на коэффициент задолженности посредством методов локальных прогнозов с одновременной корректировкой весов 9 Подробнее см. Jordà andTaylor, 2016, и Carrière-Swallow, David, andLeigh, 2021. наблюдений с использованием прогнозируемых вероятностей. Как показано на рисунке 3.3, такие корректировки не меняют вывода о том, что средняя описательная консолидация бюджета не оказывает статистически значимого влияния на коэффициент задолженности.…”

Macrofinancial Causes of Optimism in Growth Forecasts

“… 25 A recent estimate of fiscal multipliers in emerging markets is provided by Carrière-Swallow et al ( 2021 ), who report that fiscal consolidations identified using a narrative approach are associated with a multiplier of 0.9 after two years in a sample of 14 countries in Latin America and the Caribbean. They show that this estimate is much larger than many previous estimates identified using timing assumptions or cyclical adjustments.…”