Non-Linearities in Fiscal Policy:The Role of Debt

November 13, 2020

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Alexandra Fotiou. Non-Linearities in Fiscal Policy:The Role of Debt, (USA: International Monetary Fund, 2020) accessed December 26, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Empirical evidence shows that fiscal multipliers depend on the state of the cycle, the nature of fiscal policy and the level of debt. In other words, evidence points to non-linearities in the effects of fiscal policy. This paper provides a framework to examine the role of the level of government debt in the assessment of consolidation policies across the business cycle, allowing for the consolidation multiplier to depend on the level of debt at the time of consolidation. The empirical analysis, which uses a panel of 13 countries between 1980 and 2014, finds that when debt is high, fiscal consolidations based on tax increases are in general self-defeating, in that they result in an increase of the debt-to-GDP ratio. Instead, cutting public expenditure has a less pronounced effect on economic activity and can stabilize debt. The initial level of debt in an economy, when a fiscal consolidation is implemented, appears to work as a channel in explaining evidence of state-dependence of the different consolidation instruments.

Subject: Expenditure, Fiscal consolidation, Fiscal multipliers, Fiscal policy, Production, Production growth, Public debt

Keywords: Condition of a country, Debt, Debt country, Debt level, Effects of tax, Evidence of state-dependency, Expansions, Fiscal consolidation, Fiscal consolidations, Global, Indexes country, Inflation rate, Interacted-STVAR, Multiplier effect, Production growth, Recessions, Regime-switching model, Southern Europe, State indicator, State of the business cycle, State of the economy, State of the public finances, WP

Publication Details

Pages:

40
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/246
Stock No:

WPIEA2020246
ISBN:

9781513560939
ISSN:

1018-5941

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