Successful Fiscal Adjustments. Does Choice of Fiscal Instrument Matter?

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. We examine fiscal adjustment episodes in 24 OECD countries in order to find how austerity affects debt and growth, and whether the choice of fiscal instrument matters for the results. Influential existing studies argue that spending cuts are more likely to successfully reduce debt and enhance economic growth than tax increases. Our main innovations over these studies are to better account for initial conditions and to employ a novel and more precise measure of actual changes in fiscal policy. We find that whether a fiscal adjustment is successful in reducing debt depends on whether the adjustment was sufficiently large to remove the budget deficit. We find no indication that it matters whether the adjustment is achieved via spending cuts or tax increases, and this conclusion holds also for the effect on economic growth. Terms of use: Documents inJEL-Code: H200, H300, H500, H620.

Can successful fiscal adjustments only be achieved by spending cuts?

“…6 This so-called 'action-based approach' follows the 'narrative approach' used by Romer and Romer (2010) for the identification of tax changes. However, this action-based approach is not without problems (Holden and Larsson Midthjell, 2013). It might be hard to assess the true intention of a policy change solely by reading policy documents.…”

“…Their evidence is based on a model explaining the growth of government debt in 39 fiscal consolidation periods. Similarly, Ardagna (2004) and Holden and Larsson Midthjell (2013) find no indication that it matters for the success of the adjustment whether it is achieved via spending cuts or tax increases. Focusing on medium-term adjustments, Baldacci et al (2012) conclude that when adjustment needs are large, fiscal adjustments that rely on revenue-enhancing measures are more likely to accelerate debt consolidation than those based on expenditure-based cuts only.…”

“…The paper that comes closest to our work is Holden and Larsson Midthjell (2013). These authors redo the analysis of Alesina and Ardagna (2010) using a measure of changes in fiscal policy designed to avoid reverse causality.…”

Government Ideology, Monetary Policy, Fiscal Policy, and Financial Crises

“…Nevertheless, this approach also has problems (Holden and Larsson Midthjell, 2013). The fact that a policy change is announced does not imply that it will be implemented.…”