The Effects of Fiscal Consolidations: Theory and Evidence

Alberto Alesina, Omar Barbiero, Carlo Favero, Francesco Giavazzi, Matteo Paradisi

NBER Working Paper No. 23385
Issued in May 2017, Revised in November 2017
NBER Program(s):International Finance and Macroeconomics Program, Monetary Economics Program

We investigate the macroeconomic effects of fiscal consolidations based upon government spending cuts, transfers cuts and tax hikes. We extend a narrative dataset of fiscal consolidations, with details on over 3500 measures for 16 OECD countries. We show that government spending cuts and cuts in transfers are much less harmful than tax hikes, despite the fact that non-distortionary transfers are not classified as spending. Standard New Keynesian models robustly match our results when fiscal shocks are persistent. Wealth effects on aggregate demand mitigate the impact of a persistent spending cut. Static distortions caused by persistent tax hikes cause larger shifts in aggregate supply under sticky prices.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w23385

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