Cross‐Country Spillovers from Fiscal Consolidations

Abstract

In the aftermath of the global financial crisis, many OECD countries adopted fiscal consolidation strategies to reduce their debt‐to‐GDP ratios. This paper investigates the effects of fiscal consolidation on trading partners’ growth through trade linkages. Using a measure of exogenous fiscal shocks in export markets, fiscal consolidation spillovers are found to slow down domestic growth and decrease employment. To the extent that fiscal consolidations are synchronised, fiscal policies have large spillover effects on output. Spillovers of fiscal consolidations on growth are found to be initially larger between countries belonging to currency unions, though this larger impact vanishes over the medium term. Larger spillovers of fiscal consolidation coincide with lower bilateral exports, higher bilateral imports and relative increases in unit labour costs in currency unions. Spillovers of fiscal consolidation are also found to be more detrimental to domestic growth during economic downturns in export markets.

Cross‐country spillovers of fiscal consolidations in the euro area

“…Our result on the relatively stronger effect of tax consolidations is consistent with studies on fiscal multipliers using the narrative approach (Dell'Erba, Koloskova, & Poplawski‐Ribeiro, ; Leigh et al, ), but it contrasts with Goujard (), who finds a larger impact of expenditure measures, on average, over a 3‐year period for 17 OECD countries. Although there is no consensus in the literature on the size of revenue versus expenditure multipliers, there are at least two reasons why revenue multipliers are likely to be more sizeable in the euro area countries we are analysing.…”

“…We also checked the sensitivity of coefficient estimates to the monetary policy regime (currency union) and the cyclical state of the economy (bad vs. good times). The effect of fiscal consolidation on trade flows could be larger within currency unions given the absence of nominal exchange rate flexibility to cushion the impact of the shock (Bluedorn & Leigh, ; Goujard, ). Moreover, greater economic integration makes trade flows within currency unions more sensitive to changes in relative prices.…”

“…">Unlike the GVAR approach, our methodology is univariate which simplifies the interpretation of results. In addition, the identification of fiscal shocks is based on the commonly‐used narrative methodology, whereas identification in the GVAR model is based on generalized impulse responses that cannot be interpreted in a structural sense. Unlike the LPM approach of Auerbach and Gorodnichenko () and Goujard (), our empirical methodology does not assume that fiscal measures in the home country have a direct impact on the output of trading partners. Instead, fiscal measures in the home country affect domestic output, which in turn spills over to the outputs of trading partners and exerts a feedback on the home country.…”

“…Unlike the LPM approach of Auerbach and Gorodnichenko () and Goujard (), our empirical methodology does not assume that fiscal measures in the home country have a direct impact on the output of trading partners. Instead, fiscal measures in the home country affect domestic output, which in turn spills over to the outputs of trading partners and exerts a feedback on the home country.…”

“…Lopez‐Bazo, Vaya, and Artis () and Ertur and Koch () provide a theoretical justification for using spatial econometrics methods for the empirical analysis of growth by extending the neoclassical growth model. Our paper is closest in spirit to Goujard (), with several differences. First, our narrative measure of fiscal consolidations covers the post‐2009 period (Gupta, Jalles, Mulas‐Granados, & Schena, ).…”