The Output Effect of Fiscal Consolidations

Abstract

The present paper argues that the correct experiment to evaluate the effects of a fiscal adjustment is the simulation of fiscal plans rather than of individual fiscal shocks. The simulation of the fiscal plans adopted by 16 OECD countries over a 30-year period supports the hypothesis that the effects of consolidations depend on their design. Fiscal adjustments based upon spending cuts are much less costly, in terms of output losses, than tax-based ones. Fiscal adjustments have especially low output costs when they consist of permanent rather than stop and go. The difference cannot be explained by accompanying policies, including monetary policy, and appears to be mainly due to the different response of business confidence and private investment.