Are Fiscal Adjustments Contractionary?

This paper analyzes the short-term effects of fiscal adjustments on macroeconomic aggregates for a panel of 20 OECD countries during 1970–2008. We find that episodes of budget consolidation have an insignificant impact on growth and consumption. On the other hand, fiscal adjustments are associated with a significant boost in private investment, particularly when they are large and expenditure-based. This paper thus provides further evidence for the expectational view of fiscal policy according to which successful attempts by the government to reduce the deficit lead to lower risk premiums and interest rates, thereby crowding in private investment.