Fiscal Consolidations and Economic Growth

Authors


  • Submitted July 2012.

  • The authors would like to thank Manuel Arellano, Eric Leeper, an anonymous referee and Hamish Low (the Editor) for useful comments and suggestions. They are also grateful to seminar participants at Banco de España (November 2010), the Spanish Economic Association Meeting in Málaga (December 2011), the Louis-André Gérard-Varet Conference in Marseille (June 2012) and the European Economic Association Meetings in Málaga (August 2012). Special thanks are due to Silvia Ardagna and Jacopo Cimadomo for kindly sharing the data. A previous version of this paper circulated under the title ‘Endogenous Fiscal Consolidations’. The opinions and analyses are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.

Abstract

The aim of this paper is to deepen the understanding of the macroeconomic consequences of fiscal consolidations. In particular, there is evidence in the literature of fiscal consolidation episodes producing (non-Keynesian) expansionary effects in the short run. We replicate this result for a panel of OECD countries under exogeneity of the fiscal consolidation. However, we provide some evidence that output growth might affect the fiscal tightening process so that fiscal consolidations are not exogenous to economic growth. Once we allow for feedback effects from economic growth to fiscal adjustments, we find that expansionary effects disappear and recover the typical Keynesian effect of fiscal adjustments. This finding points to the need to take these short-term negative implications into account in the design of fiscal consolidations.

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