How Do Fiscal Adjustments Work? An Empirical Investigation
65 Pages Posted: 6 Jul 2021 Last revised: 30 Mar 2022 Publication Status: Published
Recent empirical evidence suggests that fiscal consolidation mainly based on tax hikes has a more recessionary impact on economic growth than those based on expenditure cuts. This paper evaluates the effects of fiscal adjustment plans identified through the narrative approach on macroeconomic activity. I incorporate fiscal plans into a vector autoregression model to investigate transmission channels of fiscal consolidation and accompanying policy. I check whether monetary policy, uncertainty, or financial markets can explain the heterogeneous effects of fiscal adjustment plans. I find that the financial market and macro uncertainty channels are the most important ones.
Keywords: fiscal adjustment plans, output, risk, financial market, uncertainty, monetary policy
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