Output Effects of Fiscal Consolidations: Does Spending Composition Matter?

This paper studies whether changes in the composition of public spending affect the macroeconomic consequences of fiscal consolidations. Based on a sample of 44 developing countries and 26 advanced economies during 1980-2019, results show that while fiscal consolidations tend to be on average, contractionary, the size of the output fall depends on the behavior of public investment vis-a-vis public consumption during the fiscal adjustment, with heterogeneous responses growing over time. When public investment is penalized relative to public consumption and thus, its share in public expenditures decreases, a 1 percent of GDP consolidation reduces output by 0.7 percent within three years of the fiscal shock. In contrast, safeguarding public investment from budget cuts vis-a-vis public consumption can neutralize the contractionary effects of fiscal adjustments on impact, and can even spur output growth over the medium term. The component of GDP that mostly drives the heterogeneity between both types of adjustments is private investment. The results hold up to a number of robust-ness tests, including alternative identification strategies of fiscal shocks. The findings have policy implications for the design of fiscal adjustment strategies to protect economic growth as countries recover from the coronavirus pandemic.consolidation reduces output by 0.7 percent within three years of the fiscal shock. In contrast, safeguarding public investment from budget cuts vis-a-vis public consumption can neutralize the contractionary effects of fiscal adjustments on impact, and can even spur output growth over the medium term. The component of GDP that mostly drives the heterogeneity between both types of adjustments is private investment. The results hold up to a number of robustness tests, including alternative identification strategies of fiscal shocks. The findings have policy implications for the design of fiscal adjustment strategies to protect economic growth as countries recover from the coronavirus pandemic.

Public Finance and Fiscal Policy in South Africa

This chapter explores the trajectory of post-apartheid fiscal policy, focusing on the growth, equity, and sustainability trends between 2009 and 2019. Buoyed by the commodity boom, the African National Congress governing party strengthened fiscal institutions, improving the credibility and solvency of fiscal policy in the first fourteen years after the democratic transition. The decade after the global financial crisis in 2008 saw declining potential growth rates, deteriorating terms of trade, the institutionalization of state capture during the Zuma administration until 2018, policy uncertainty, widespread electricity outages, and a burgeoning public-sector wage bill. Rising deficits, debt, and state-owned-enterprise contingent liabilities triggered austerity without genuine fiscal consolidation. The coronavirus pandemic amplified these unsustainable trends arising from deferred structural fiscal adjustment.

Midterm polls will knock Argentine budget off course

Significance The debate has been delayed by November 14 midterm elections. However, the budget has already been criticised both by the opposition, which considers the forecasts excessively optimistic, and by Vice-President Cristina Fernandez de Kirchner (CFK) and her supporters, who believe fiscal tightening in the first half was responsible for the government’s poor performance in the August open primaries. Impacts The 2021 budget deficit will be narrower than initial expectations thanks to the sharp fiscal adjustment in the first half. Next year’s fiscal adjustment will involve cutting energy subsidies, prompting higher tariffs and inflation. Absent new foreign credit, increased Central Bank transfers to the Treasury could fuel an inflationary spiral.

Ecuador economy plans may run into difficulties

Significance The second had been delayed pending the inauguration of President Guillermo Lasso and confirmation of his commitment to the agreement’s objectives. Lasso reached a new deal last month which unlocks two new tranches under Ecuador’s existing USD6.5bn loan programme, while facilitating a more gradual fiscal adjustment than that agreed by his predecessor. Impacts Crisis measures in the banking system will be unwound later in the year to preserve the sector’s health and avoid creating distortions. Lasso will strive to accelerate Ecuador’s incorporation into the Pacific Alliance trade bloc. Lasso’s plan to double oil output through risk-sharing agreements with the private sector will probably prove over-optimistic.

Argentina's investment outlook improves for now

Significance The rebound of commodities prices fuelled new investments in agroindustry and the energy and mining sectors, while the lifting of lockdown measures helped to boost private consumption, triggering new investments to expand production. Import restrictions drove import substitution in many manufacturing industries, while public works and lower dollar costs boosted construction. Impacts New investments in mining, energy and agriculture would enhance productivity and Argentina’s role as a commodity producer. Some manufacturing sectors will benefit from import substitution while others will focus on their role in global value chains. Political instability may undermine the investment recovery, while any fiscal adjustment would hit construction.

Revenue vs expenditure based fiscal consolidation: the pass-through from federal cuts to local taxes

A growing literature emphasizes that the output effect of fiscal consolidation hinges on its composition, as the choice of increasing revenues vs cutting expenditure is not neutral. Existing studies, however, underscore the role of local governments in a federal setting. Indeed, transfer cuts at the central level might translate into higher local taxes, changing the effective composition of the fiscal adjustment. We evaluate this transmission mechanism in Italy, where municipalities below the threshold of 5,000 inhabitants were exempted from (large) transfer cuts in 2012. This allows us to implement a difference-in-discontinuities design in order to estimate the causal impact of transfer cuts on the composition of fiscal adjustment, also because tight fiscal rules impose a balanced budget on Italian municipalities. We find a pass-through mechanism by which local governments react to the contraction of intergovernmental grants by mainly increasing taxes rather than reducing spending. From a political economy perspective, this revenue based fiscal consolidation is driven by local governments with low electoral competition and low party fragmentation.

The New Fiscal Normal: Vaccinations, Debt, and Fiscal Adjustment in Emerging Economies

What is the potential impact of vaccination programs and different fiscal adjustment scenarios on countries after suffering the macro-fiscal effects of the pandemic? We calibrate a DSGE model with an epidemiological module for the average Latin American and Caribbean economy that uses fiscal policy and vaccination to contain these effects. We nd that there is a trade-off in the application of one of these policies. Focusing on vaccination has a high return in saving lives and improving economic growth but a lower fiscal adjustment. We conclude that simultaneous vaccination and fiscal reform is a successful policy combination that helps countries mitigate the health effects of the pandemic, reduce the economic cost of fiscal policy, and move toward a path of fiscal consolidation.

Fiscal adjustments, income inequality and economic growth: an empirical analysis of Japanese prefectures

PurposeThis paper investigates the joint relationship between economic growth, income inequality and fiscal adjustments using a panel of 47 Japanese prefectures from 1998 to 2017.Design/methodology/approachTo assess jointly fiscal adjustment impacts on growth and inequality and to take into account the interdependence between these variables, the authors use a simultaneous equation model and estimate it by using the three-stage least squares estimation method.FindingsThe results show evidence of a trade-off between growth and inequality through fiscal adjustments. They reveal that first, fiscal adjustments have contractionary effects on growth. Second, they highlight the disparity between urban and rural taxpayers. Third, they provide evidence of a trade-off between fiscal adjustments and inequality through the labor market.Research limitations/implicationsBased on the literature, the composition of fiscal adjustments is a crucial factor in analyzing fiscal adjustment impacts on economic growth and income inequality. The authors do not consider this aspect in the analysis; however, fiscal policy outcomes variables are included as a workaround for this.Practical implicationsThese results suggest that authorities favor expenditure-based adjustments as they are less contractionary on the economy. Moreover, they should finance public expenditures through a tax on capital in order to mitigate fiscal adjustment impacts on inequality while promoting growth.Originality/valueThe paper is novel in testing the existence of a trade-off between economic growth and income inequality through fiscal adjustments at a sub-national level with an additional focus on urban and rural regions.

A Dynamic Analysis of the Impact of Fiscal Adjustment on Economic Growth: Evidence From Pakistan

This study claims to be the first in assessing the short-run and long-run impacts of both the size and composition of fiscal adjustment on the growth in Pakistan. Empirical calibration has been made on Mankiw et al.’s model, while the Autoregressive Distributed Lag (ARDL) techniques of Pesaran et al. have been employed to carry out the estimation. To cure the problem of degenerate cases, the ARDL techniques have been augmented with the model of Sam et al. The analysis supports the hypothesis of “expansionary fiscal contraction” in the long run. The analysis reveals that the spending-based adjustment enhances the economic growth, whereas the tax-based adjustment would reduce the growth in the long run in the case of Pakistan. The Granger causality test indicates that the fiscal adjustments have been weakly exogenous, thereby allowing feedback effect from the economic growth toward the fiscal adjustment. Thus, the objective of sustained economic growth can be achieved through the spending-based consolidation measures.