DP10902 The Permanent Effects of Fiscal Consolidations

Author(s): Antonio Fatás, Lawrence Summers
Publication Date: October 2015
Keyword(s): austerity, fiscal policy, Great Recession, hysteresis, persistence
JEL(s): E32, E62, O40
Programme Areas: Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10902

The global financial crisis has permanently lowered the path of GDP in all advanced economies. At the same time, and in response to rising government debt levels, many of these countries have been engaging in fiscal consolidations that have had a negative impact on growth rates. We empirically explore the connections between these two facts by extending to longer horizons the methodology of Blanchard and Leigh (2013) regarding fiscal policy multipliers. Using data seven years after the beginning of the crisis as well as estimates on potential output our analysis suggests that attempts to reduce debt via fiscal consolidations have very likely resulted in a higher debt to GDP ratio through their negative impact on output. Our results provide support for the possibility of self-defeating fiscal consolidations in depressed economies as developed by DeLong and Summers (2012).