Expansionary Austerity? International Evidence

Abstract

This paper investigates the short-term effects of fiscal consolidation on economic activity in OECD economies. 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 prospective economic conditions. Using this new dataset, our estimates suggest that fiscal consolidation has contractionary effects on private demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects. (JEL: E32, E62, H20, H5, N10)

When do fiscal consolidations lead to consumption booms? Lessons from a laboratory experiment

“…While several authors report instances of fiscal consolidations that were accompanied by higher GDP growth (see e.g. Perotti, 1999;van Aarle and Garretsen, 2003;Alesina and Ardagna, 2010), a number of studies reaches opposite conclusions (Guajardo et al, 2014;Jordà and Taylor, 2013). Also, from a broader perspective, the literature on fiscal multipliers is similarly ambiguous and reports a wide range of estimated multipliers (Cogan et al, 2010;Ramey, 2011).…”

Medium-Term Fiscal Multipliers during Protracted Recessions

“…The analysis of fiscal multipliers with respect to labor market variables has been in fact largely overlooked with the notable exception of Monacelli et al (2010). 3 In line with recent contributions from the post-crisis literature, fiscal consolidation episodes are identified via the narrative approach using the dataset constructed by Devries et al (2011) and Guajardo et al (2014). This dataset identifies fiscal shocks that are motivated by the desire to reduce the public deficit, hence exogenous to cyclical considerations.…”

“…This allows a correct inference in the estimation of fiscal multipliers. 8 IMF (2010a) and Guajardo et al (2014) show that, by using the Devries et al's (2011) dataset, fiscal consolidations are contractionary, albeit spending-based consolidations are less so than the tax-based ones in the short term.…”

“…The results from this identification approach are that fiscal adjustments can have expansionary effects, particularly if based on spending cuts rather than tax increases. 7 IMF (2010a) and Guajardo et al (2014) argue that the episodes of consolidations identified with the CAPB are biased toward overstating expansionary effects of austerity measures. Thus, they study episodes of fiscal consolidations identified with the narrative approach.…”

“…This is motivated by the long empirical and theoretical literature on the effects of government spending and taxes on output and its components (e.g., Guajardo et al, 2014). Neoclassical models suggest that an increase in taxes can be highly contractionary due to a combination of negative wealth effect on consumption with distortions on the supply side, whereas a cut in spending could stimulate economic activity if it is associated with a decrease in distortionary taxation.…”