Τhe short run effects of fiscal adjustment in OECD countries

Abstract

This paper investigates the short-run effects of fiscal consolidation on various macroeconomic aggregates in a group of 24 OECD economies from 1990 to 2019.The empirical findings suggest that an unanticipated fiscal consolidation shock is contractionary. The effects are more pronounced in recessions, in high debt countries, in closed economies and when monetary conditions are tight. Consequently, in these cases, the decline of the public debt ratio is more subdued. Spending-based adjustments that are implemented in recessions, in periods with tight monetary conditions and when the debt ratio is above 80% are self-defeating. Fiscal consolidations that are initiated in expansions, in cases of low debt ratios, when monetary conditions are loose and in open economies can be expansionary and lead to a more pronounced decline in the debt ratio. This is particularly true for spending-based adjustments that are initiated in expansions and in periods with loose monetary conditions. These findings are particularly relevant in the current adverse macroeconomic environment as they can help in the design of an effective fiscal consolidation programme.