IMF working paper : "Successful Austerity in the United States, Europe and Japan"
01/07/2012Abstract:
The output effects of 2009 fiscal expansions have been hotly debated. But the discussion of
fiscal multipliers is even more relevant now that several European countries have had to quickly
retract their stimulus measures in an effort to regain market confidence. Using regime-switching
VARs we estimate the impact of fiscal adjustment on the United States, Europe and Japan allowing
for fiscal multipliers to vary across recessions and booms. We also estimate ex ante probabilities of
recessions derived in association with different-sized and different types of consolidation shocks
(expenditure- versus tax-based). We use these estimates to understand how consolidations should be
designed to be most effective in terms of permanently and rapidly reducing a country’s debt-to-GDP
ratio. The main finding is that smooth and gradual consolidations are to be preferred to frontloaded or
aggressive consolidations, especially for economies in recession facing high risk premia on public
debt, because sheltering growth is key to the success of fiscal consolidation in these cases.
JEL Classification Numbers: E62; F41; H30; H63
The output effects of 2009 fiscal expansions have been hotly debated. But the discussion of
fiscal multipliers is even more relevant now that several European countries have had to quickly
retract their stimulus measures in an effort to regain market confidence. Using regime-switching
VARs we estimate the impact of fiscal adjustment on the United States, Europe and Japan allowing
for fiscal multipliers to vary across recessions and booms. We also estimate ex ante probabilities of
recessions derived in association with different-sized and different types of consolidation shocks
(expenditure- versus tax-based). We use these estimates to understand how consolidations should be
designed to be most effective in terms of permanently and rapidly reducing a country’s debt-to-GDP
ratio. The main finding is that smooth and gradual consolidations are to be preferred to frontloaded or
aggressive consolidations, especially for economies in recession facing high risk premia on public
debt, because sheltering growth is key to the success of fiscal consolidation in these cases.
JEL Classification Numbers: E62; F41; H30; H63