Τhe effects of fiscal consolidation in OECD countries

Abstract

Fiscal consolidation is essential for safeguarding fiscal sustainability in many OECD countries in the post COVID-19 era. Several empirical studies have presented evidence in favor of expansionary fiscal consolidations. This paper using the local projection method, investigates the short-to medium-term effects of unanticipated fiscal consolidation shocks in 24 OECD countries from 1990 to 2019. Fiscal consolidations are contractionary according to our baseline model. This effect is more pronounced in recessions, in high debt countries, in closed economies and when monetary conditions are tight. Therefore, the decline in the public debt ratio is relatively small. Spending-based adjustments that are implemented in recessions, in periods with tight monetary conditions and when the debt ratio is above 80% are self-defeating. Fiscal consolidations that are initiated in expansions, in low debt countries, when monetary conditions are loose and in open economies can be expansionary and lead to a more pronounced decline in the debt ratio. • A fiscal consolidation is contractionary delaying the reduction of the debt ratio. • Spending-based adjustments can be self-defeating if implemented in recessions. • The same holds for tight monetary conditions and when the debt ratio is above 80%. • However, fiscal adjustments can be expansionary when monetary conditions are loose. • The same holds when the debt ratio is below 60% and in more open economies.