Fiscal Consolidation = Short-Term Contraction, Long-Term Expansion
Sparked by rising sovereign default risks and mounting debts across the globe, many countries are confronting serious calls for fiscal consolidation. Such consolidations, which take the form of tax increases or spending cuts, may increase long-term economic growth. But because they have a contractionary effect on short-term growth, consolidations can be politically difficult to achieve. The contractionary effects of consolidations vary significantly depending on both the type of consolidation (i.e., spending cuts or tax increases), and the conditions prior to and surrounding the consolidation.
A new study by the International Monetary Fund (IMF) provides important evidence for countries seeking to minimize the contractionary effects of fiscal consolidation. The IMF study investigates the historical implications in advanced economies of fiscal consolidation on factors such as GDP, unemployment, demand, and interest rates. In particular, it examines: (i) the different impacts of tax-based versus spending-based fiscal consolidations; (ii) variance by types of spending cuts and tax increases; and (iii) possible changes in expected impacts of consolidation in light of current conditions such as near-zero policy rates and worldwide, simultaneous consolidations.
Download full PDF study below.