Discussion paper
DP12016 The effects of Fiscal Consolidations: Theory and Evidence
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, finding details on over 3500 measures. Government spending
and transfer cuts are much less harmful than tax hikes. Standard New Keynesian models
match our results when fiscal shocks are persistent. Wealth effects on aggregate
demand mitigates the impact of a persistent spending cut. Static distortions caused by
persistent tax hikes cause larger shifts in aggregate supply under sticky prices. This
channel explains different sizes of multipliers found in fiscal stimuli compared to consolidation
plans.
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