The Economic Effects of Fiscal Consolidation with Debt Feedback

IMF Working Papers, May 31, 2013

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Canonical URL: The Economic Effects of Fiscal Consolidation with Debt Feedback

Authors: Marcello M. Estevão, Issouf Samaké
Date: May 31, 2013
Core question: How to balance fiscal stimulus and fiscal consolidation by measuring fiscal multipliers when quarterly data are scarce and debt feedback effects matter.
Main approach: Estimate fiscal multipliers using a novel methodology to identify fiscal shocks within a structural vector autoregressive approach using annual data while controlling for debt feedback effects.

Identification strategy: Structural vector autoregressive (SVAR) / SVECM approach adapted to annual data to identify exogenous fiscal policy shocks.
Special treatment: Controls for debt feedback effects in the estimation.
Validation: Uses results for advanced economies, emerging market countries, and other broad groupings for which alternative estimates are available to validate the methodology.
Geographic focus: Regions with scarce quarterly data (mostly low-income countries).

Fiscal multiplier estimation:
- Fiscal multipliers are estimated using a novel methodology for identifying fiscal shocks within a structural vector autoregressive approach using annual data while controlling for debt feedback effects.
Differential effects by country group:
- Differently from advanced and emerging market economies, fiscal consolidation in low-income countries has only a small temporary negative effect on growth while raising medium-term output.
Composition of spending:
- Shifting the composition of public spending toward capital expenditure further supports long-run growth.

In low-income countries:
- Fiscal consolidation can have only a small temporary negative effect on growth and can raise medium-term output, suggesting consolidation need not always be contractionary over the medium term.
- Reorienting public spending toward capital expenditure is recommended to support long-run growth.
For empirical fiscal policy analysis:
- When quarterly data are unavailable, annual-data SVAR methods that control for debt feedback can provide credible estimates of fiscal multipliers and inform policy choices.

Subject: Current spending, Expenditure, Fiscal consolidation, Fiscal multipliers, Fiscal policy, Revenue administration
Keywords: A. fiscal policy, Central America, Consolidation, counter-cyclical fiscal policy, Current spending, current spending multiplier, debt feedback effect, emerging market country, Fiscal consolidation, Fiscal mulpiliers, Fiscal multipliers, fiscal policy policy change, fiscal policy reaction, fiscal policy shock, Global, Identification, oil-producer country, spending cut, spending multiplier, Sub-Saharan Africa, SVECM, tax shock, WP