Non-Keynesian Fiscal Consolidation in the EU? Ex Post Evidence and Ex Ante Analysis

Abstract

This Paper analyses the occurrence of non-Keynesian effects in fiscal consolidations in the EU. The analysis is carried out both ex post, i.e., by looking at the emergence of expansionary consolidations in the past and at their characteristics, and ex ante, i.e., by simulating with the European Commission QUEST model under which conditions public finance consolidation would exhibit non-Keynesian effects in the current EMU context. Cross-country analysis shows that roughly half of the episodes of fiscal consolidations that have been undertaken in the EU in the last 30 years have been followed by an acceleration in growth. The consolidations that turned out to be expansionary were, in general, based on expenditure cuts rather than on revenue increases. Simulations with the QUEST model show that expansionary effects from fiscal consolidations can emerge in the short/medium run provided that consolidations are expenditure-based. Irrespective of the type of expenditure cut simulated, non-Keynesian effects in QUEST are associated with a reaction of aggregate consumption to expected future incomes; in the case of cuts to the government wage bill the investment channel is also relevant.

Keywords: Fiscal policy in the EU, fiscal consolidations, non-keynesian effects of fiscal policy

JEL Classification: E63, H30, H63