Fiscal Consolidation: What Are the Breakeven Fiscal Multipliers?

Abstract

This article derives time-varying threshold multipliers for G7 countries and the euro area, above which consolidation will be self-defeating (that is, leading to an increase rather than a decrease in the debt-to-GDP ratio). Simulations suggest that these thresholds have declined since the financial crisis. In addition to the length of the consolidation period, and the pace of consolidation, the initial level of public debt would be the main factor affecting these multipliers. Results are robust to alternative calibration of the model and suggest that it may be advisable to delay consolidation in countries where the recovery is still fragile, as the conditions for fiscal consolidation not to be self-defeating are stricter than those prevailing in the pre-crisis period. Consolidation packages should also rely on measures where multipliers are the lowest to ensure that threshold multipliers are not exceeded.