The main findings from the analysis can be summarized as follows:
1. Fiscal expenditure multipliers are significantly larger in downturns than in upturns;
2. While it is plausible to conjecture that confidence effects have been at play in oursample of consolidations, during downturns they do not seem to have ever been strongenough to make the consolidations expansionary at least in the short run;
3. Expenditure multipliers (where expenditure is defined as public consumption andinvestment only) are significantly larger than tax multipliers (where tax is defined as taxminus transfers) in downturns;
4. Monetary policy does not seem to have a strong cushioning effect on economicactivity against fiscal withdrawals implemented during downturns—possibly reflecting thefact that during the actual downturns experienced by the countries of our sample, over ourestimation horizon, interest rates may not have been cut sufficiently (or cut sufficiently fast)to counteract the drop in output that accompanied the episodes of fiscal consolidation.Theweak cushioning effect of monetary policy may also be due to the fact that some of thedownturns in our sample might actually be induced by the monetary authorities in an effort tolower inflation;
5. The probability that a fiscal consolidation initiated in a downturn deepens or extendsthe downturn is almost twice as large as the probability that a consolidation started in anupturn triggers a downturn;
6. “Strong” (defined as 2 standard deviation fiscal shocks) consolidations are 20 percentmore likely to trigger or extend downturns than “mild” (defined as 1 standard deviation fiscalshocks) consolidations. In other words, the same fiscal adjustment is less recessionary ifmade via an extended adjustment as opposed to a more abrupt one;
7. The exact size of the 1-year cumulative fiscal multiplier is country-, time-, andcircumstance-specific, with ranges in our sample countries (in downturns) between 1.6 and2.6 for expenditure shocks, and 0.16 and 0.35 for tax shocks.
8. The peak effect on output of fiscal consolidations is within the first year from theshock.
9. Frontloaded consolidations tend to be more contractionary and, hence, delay thereduction in the debt-to-GDP ratio relative to smoother consolidations.
The key policy implications from the analysis are thus:
– Implementing fiscal consolidations during periods of positive output growth reducessignificantly the impact on output;
– If consolidations need to be implemented during downturns (for instance, to regainmarket confidence), they should prioritize increases in net taxes (defined as taxesminus transfers);
– If consolidations have to occur during downturns and prioritize cuts in publicconsumption and investment, they should be smooth and gradual and be accompaniedby increases in net taxes. When the fiscal adjustment relies more heavily on net taxincreases than on expenditure cuts, and is gradual, the debt-to-GDP ratio falls bymore, while affecting output less adversely;
– Monetary policy should be used more proactively to mitigate the output costs ofconsolidations;
– Measures that improve the credibility and durability of consolidations may boostpositive confidence effects, alleviating the cost of future consolidations. In theEuropean context, for example, a strong commitment to a responsible implementationof the European Union’s “Fiscal Compact” may be warranted in this regard;
– Last but not least, more empirical research is needed to understand the size andregime-dependency of multipliers of subcomponents of expenditure, since it is likelythat some expenditure cuts are more output-costly than others (our estimates suggestthat, historically, the kind of expenditure cuts used were costly in terms of foregoneoutput); moreover, our analysis abstracts from the role of debt levels, which havebeen shown to significantly reduce growth, especially when they exceeds a specificthreshold, usually estimated around 90 percent of GDP (see Kumar and Woo, 2011,and Baum, Checherita and Rother, 2012). Extending the research in this directioncould give us further information on the appropriate policy mix in highly-indebtedcountries and, indirectly, in situations where fiscal consolidation is implemented inconditions of near-default.
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