Fiscal Multipliers and Public Debt Dynamics in Consolidations

Abstract

The success of a consolidation in reducing the debt ratio depends crucially on the value of the multiplier, which measures the impact of consolidation on growth, and on the reaction of sovereign yields to such a consolidation. We present a theoretical framework that formalizes the response of the public debt ratio to fiscal consolidations in relation to the value of fiscal multipliers, the starting debt level and the cyclical elasticity of the budget balance. We also assess the role of markets confidence to fiscal consolidations under alternative scenarios. We find that with high levels of public debt and sizeable fiscal multipliers, debt ratios are likely to increase in the short term in response to fiscal consolidations. Hence, the typical horizon for a consolidation during crises episodes to reduce the debt ratio is two-three years, although this horizon depends critically on the size and persistence of fiscal multipliers and the reaction of financial markets. Anyway, such undesired debt responses are mainly short-lived. This effect is very unlikely in non-crisis times, as it requires a number of conditions difficult to observe at the same time, especially high fiscal multipliers.

The European debt crisis and fiscal reactions in Europe 2000–2014

“…This choice is predicted by the desire to isolate the effect from the business cycle to the primary balance and exclude the effect from the primary balance to the business cycle. Boussard et al (2012) find that the latter effect can be substantial, in which case ordinary fixed effect estimations would presumably lead to lower estimates of the cyclical reaction. This is indeed the case as illustrated in Table B.1 in Appendix B where the results of estimating (1) using ordinary fixed effect least squares are presented.…”

“…The rate of economic growth over the last four quarters, G4Y, may be affected by the fiscal stance in the four quarters "covered" by the variable. Indeed, studies suggest that fiscal policy is effective, albeit to varying degrees, in all EU countries (Boussard et al 2012).…”

TARGET2 Imbalances and the ECB as Lender of Last Resort

“…For a full discussion on this issue, see Buiter and Rahbari [36]. 29 This conclusion is also confirmed by the European Commission [42]; see also Boussard et al [43]. 30 In fact, at the end of 2014, TARGET2 imbalances were higher than their pre-crisis level; but they could reflect both the ordinary working of a monetary union where some peripheral countries are experiencing a slower recovery compared to core countries and the contagion effect connected with the new Greek political crisis.…”

Small Fiscal Multipliers Do Not Justify Austerity: A Macroeconomic Accounting Analysis of Public Debt-to-GDP Dynamics

“…While a comprehensive literature review can be found in Boussard, Castro, and Salto (2012), we shall recall here some of the most relevant contributions.…”