The output effect of fiscal consolidation plans

Abstract

The key question in estimating the effects of fiscal policy on output is how to identify shifts in fiscal policy that are "exogenous", that is are not a response to the state of output -as would be the case, for instance, of a fiscal expansion induced by a fall in output. Following the approach pioneered by Romer and Romer (2010), Devries at al (2011) have collected and described -using the records available in official documents -the multi-year fiscal consolidation plans announced (and then implemented or revised) by seventeen OECD countries over a quarter of a century . Among all stabilization plans these authors have selected those that were designed to reduce a budget deficit and to put the public debt on a sustainable path, which should guarantee their "exogeneity".Using the Devries et al (2011) data we have been able to make progress on question of anticipated versus unanticipated shifts in fiscal policy and permanent versus transitory shifts. We find that it matters crucially how the consolidation occurs. Fiscal adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. The difference is remarkable in its size and it cannot be explained by different monetary policies during the two types of adjustments. We find instead that the heterogeneity in the effects of the two types of fiscal adjustments is mainly due to the response of private investment, rather than that to consumption growth. Interestingly, the responses of business and consumers' confidence to different types of fiscal adjustment show the same asymmetry as investment and consumption: business confidence (unlike consumer confidence) picks up immediately after expenditure-based adjustments.The strength and the statistical significance of our results depend crucially on the innovative approach that we adopt to simulate the impact of fiscal adjustments. Rather than simulating the impact of exogenous fiscal shocks, we study the response of output (and of the other variables of interest) to multi-period fiscal consolidation plans -that is sequences of tax increases and spending cuts, announced in some year and then implemented or revised in subsequent years. We allow for differences in the "style" of these plans across countries, and we show that these differences are a critical factor in order to obtain more precise estimates of the response of the economy to a consolidation plan.The output effect of fiscal consolidation plans Alberto Alesina, Carlo Favero and Francesco Giavazzi * This version: October 2014 AbstractWe show that the correct experiment to evaluate the effects of a fiscal adjustment is the simulation of a multi year fiscal plan rather than of individual fiscal shocks. Simulation of fiscal plans adopted by 16 OECD countries over a 30-year period supports the hypothesis that the effects of consolidations depend on their design. Fiscal adjustments based upon spending cuts are much less costly, in terms of output losses, than tax-based ones and have especially low output costs when they consist...

Fiscal Consolidation Programs and Income Inequality

“…Blanchard and Leigh (2013) and Blanchard and Leigh (2014) find a negative effect of fiscal consolidation programs on output and shows that this effect is underestimated by the IMF. The conclusions in Alesina et al (2015b) support previous studies, emphasizing that tax-based consolidations produce deeper and longer recessions than spending based ones. Pappa et al (2015) study the impact of fiscal consolidation episodes in an environment with corruption and tax evasion, and find evidence that fiscal consolidation causes large output and welfare losses.…”

The Impact of Taxes on the Consumption to Income Ratio

“…In these publications, authors defended the view that expenditure cuts, as compared with tax increases, are less harmful. Certain statements and conclusions speak for themselves, such as that debt reduction was associated with higher growth rates if it was achieved by spending cuts and not by the increases in taxes (Alesina and Ardagna 2010), or that expenditure-based adjustments can be associated with minor output losses and a quick recovery of investors' confidence (Alesina et al 2015).…”

The Long-Run Effect of Fiscal Consolidation on Economic Growth: Evidence from Quantitative Case Studies

“…Alesina et al (2015) who confirm the absence of 'non-Keynesian' effects applying a seemingly unrelated regression model (SUR). The authors emphasise a milder negative effect of fiscal adjustments that are based on spending cuts rather than on revenue increases.…”

“…However, due to the economic recession, also the implementation of growth enhancing (or, at least, growth preserving policies) looms large. Given this trade-off, the austerity debate centers around the question whether fiscal consolidations undermine the prospects for (long-run) economic growth (see, for instance, the most recent contributions by Alesina et al (2015), Bilbao-Ubillos and Fernandez-Sainz (2014), Guajardo et al (2014), Hernández de Cos and Moral-Benito (2013), and Yang et al (2015)). …”