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Fiscal Consolidation During a Depression

  • Nitika Bagaria
  • Dawn Holland
  • John Van Reenen

In 2009-10, the UK's budget deficit was about 11 per cent of GDP. A credible plan for fiscal consolidation was introduced in the UK over the fiscal years 2011-12 to 2016-17. In this paper, we assess the impact of the scale and timing of this fiscal consolidation programme on output and unemployment in the UK. During a prolonged period of depression when unemployment is well above most estimates of the NAIRU, the impact of fiscal tightening may be different from that in normal times. We contrast three scenarios: the consolidation plan implemented during a depression; the same plan, but with implementation delayed for three years when the economy has recovered; and no consolidation at all. The modelling confirms that doing nothing was not an option and would have led to unsustainable debt ratios. Under both our "immediate consolidation" scenario and the "delayed consolidation", the necessary increases in taxes and reductions in spending reduce growth and increase unemployment, as expected. But our estimates indicate that the impact would have been substantially less, and less long-lasting, if consolidation had been delayed until more normal times. The impact is partly driven by the heightened magnitude of fiscal multipliers, and exacerbated by the prolongation of their impact due to hysteresis effects. The cumulative loss of output over the period 2011-21 amounts to about £239 billion in 2010 prices, or about 16 per cent of 2010 GDP. And unemployment is considerably higher for longer - still 1 percentage point higher even in 2019.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Special Papers with number 27.

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Date of creation: Aug 2012
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Handle: RePEc:cep:cepsps:27
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEPSP

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