The confidence effects of fiscal consolidations

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. (2014) show that consolidations, and in particular their unanticipated components affect confidence negatively. The effects are stronger for revenue-based measures and when institutional arrangements, such as fiscal rules, are weak. To obtain a more accurate picture of how consolidations affect confidence, we construct a monthly dataset of consolidation announcements based on the aforementioned datasets, so that we can study the confidence effects in real time using an event study. Consumer confidence falls around announcements of consolidation measures, an effect driven by revenue-based measures. Moreover, the effects are most relevant for European countries with weak institutional arrangements, as measured by the tightness of fiscal rules or budgetary transparency. The effects on producer confidence are generally similar, but weaker than for consumer confidence. Long-term interest rates, as a measure of confidence in the sovereign, tend to fall around spending-based consolidation announcements that take place in slump periods. Overall, if confidence is a concern and consolidation is unavoidable, spending-based measures seem preferable. Slump periods are not necessarily bad moments for such measures, while strengthening institutional arrangements may help in mitigating adverse confidence effects. Terms of use: Documents in EconStor mayKeywords: consolidation plans, announcements, revenues, spending, consumer-and business confidence, long-term interest rates, institutional quality, event study. However, also in this case, it emerges that spending-based consolidations tend to be less harmful than tax-based ones.In a final step, we investigate how consolidation announcements affect confidence in the sovereign, as measured by the long-term interest rate on public debt. We find that consolidation announcements tend to reduce long-term interest rates. This effect seems to be mainly driven by spending based consolidations. In addition, the interest rate reduction is particularly strong for European countries and during periods of slumps.Our findings point to some potentially useful policy implications. If confidence is important and consolidation is unavoidable then there is a strong case for resorting to spending-based consolidation. In contrast to the rather commonly-held view, a slump period may not be a bad moment for a spending-based consolidation. Finally, solid institutional arrangements in the form of tight fiscal rules and transparent budgets could h...

Macroeconomic Effects of Government Spending: The Great Recession was (Really) Different

“…In a similar vein, Beetsma et al. () show that changes in private sector confidence in response to fiscal consolidations are important to understand how fiscal budget consolidation efforts affect economic activity. Guimares et al.…”

“…Moreover, they find that the strength of this effect crucially depends on the state of the business cycle: significant increases in confidence and large fiscal multipliers during recessions are accompanied by no significant confidence response and small fiscal multipliers during economic expansions. In a similar vein, Beetsma et al (2015) show that changes in private sector confidence in response to fiscal consolidations are important to understand how fiscal budget consolidation efforts affect economic activity. Guimares et al (2016) study the confidence channel in a theoretical framework.…”

“…Moreover, also Guimaraes, Machado, and Ribeiro () and Beetsma et al. () argue in favor of the existence of a separate “confidence channel” of fiscal policy. We will discuss the potential role of this channel in affecting the response of private consumption to government spending shocks below in Section 3.…”

“…Finally, the inclusion of an indicator of consumer confidence, cc t , follows the argument by Bachmann and Sims (2012), who find that confidence is an important determinant of the way in which fiscal policy innovations affect aggregate economic activity. Moreover, also Guimaraes, Machado, and Ribeiro (2016) and Beetsma et al (2015) argue in favor of the existence of a separate "confidence channel" of fiscal policy. We will discuss the potential role of this channel in affecting the response of private consumption to government spending shocks below in Section 3.…”

“…This, in turn, would stimulate economic activity because active fiscal policy preserved the economy from an even larger contraction. The confidence channel of fiscal policy has recently been empirically explored by Bachmann and Sims (2012) and Beetsma et al (2015), and a theoretical model highlighting this channel has been proposed by Guimaraes, Machado, and Ribeiro (2016). More generally, Barsky and Sims (2012) show that confidence innovations are associated with sizeable consumption and income growth.…”