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Choosing the Pace of Fiscal Consolidation

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  • Łukasz Rawdanowicz

    (OECD)

Abstract

In many OECD countries debt has soared to levels threatening fiscal sustainability, necessitating its reduction over the medium to longer term. This paper uses stylised simulations in a small, calibrated macroeconomic model which features endogenous interactions between fiscal policy, growth and financial markets. Simulations are done for a hypothetical economy, reflecting key characteristics of fiscally stressed OECD countries. Given the assumed objective to stabilise debt at a 60% of GDP target within 20 years, a consolidation path is chosen by maximising cumulative GDP growth and minimising cumulative squared output gaps. The simulations highlight four issues. First, lowering the debt-to-GDP ratio within a finite horizon requires big initial consolidation which can be largely unwound if debt is to be stabilised at a lower level. Second, some frontloading of the adjustment turns out to be optimal in case of an interest rate shock. Third, debt reduction with high fiscal multipliers, hysteresis effects and adverse market reactions involves protracted large negative output gaps and deflation. This stresses the importance of selecting reasonable fiscal targets consistent with market conditions. Fourth, delaying the attainment of the debt target by two years has generally little implications for initial consolidation, though under adverse conditions this would result in much higher debt and slower growth. Choisir le rythme de l'assainissement budgétaire Dans de nombreux pays de l'OCDE, la dette a atteint des niveaux menaçant la viabilité budgétaire, nécessitant sa réduction à moyen et à long terme. Ce document utilise des simulations stylisées mises en oeuvre avec un petit modèle macroéconomique calibré qui tient compte des interactions endogènes entre la politique budgétaire, la croissance et les marchés financiers. Les simulations sont réalisées pour une économie fictive reflétant les principales caractéristiques des pays de l'OCDE en difficulté budgétaire. Compte tenu de l'objectif de stabiliser la dette à 60% du PIB à horizon de 20 ans, le chemin de l’assainissement est choisi par la maximisation de la croissance cumulée du PIB et par la minimisation des carrés des écarts de production. Les simulations mettent en évidence quatre problèmes. Tout d'abord, l'abaissement du ratio dette sur PIB à horizon fini exige une grande consolidation initiale qui peut être largement annulée par la suite si la dette doit être stabilisée à un niveau inférieur. Deuxièmement, une montée en charge plus rapide de l’assainissement est optimale en cas de chocs de taux d'intérêt. Troisièmement, en cas de multiplicateurs fiscaux élevés, de phénomènes d'hystérèse et de réactions défavorables des marchés, la réduction de la dette implique des périodes prolongées d’écarts de production négatifs importants et de déflation. Cela souligne l'importance de choisir des objectifs budgétaires raisonnables et compatibles avec les conditions de marché. Quatrièmement, reporter l'assainissement et l’atteinte des objectifs de dette de deux ans a généralement des répercussions légères sur la consolidation initiale, mais dans des conditions défavorables, il en résulte une dette beaucoup plus élevée et une croissance beaucoup plus lente.

Suggested Citation

  • Łukasz Rawdanowicz, 2012. "Choosing the Pace of Fiscal Consolidation," OECD Economics Department Working Papers 992, OECD Publishing.
  • Handle: RePEc:oec:ecoaaa:992-en
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    File URL: http://dx.doi.org/10.1787/5k92n2xg106g-en
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    References listed on IDEAS

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    1. repec:nbr:nberch:13342 is not listed on IDEAS
    2. Nathalie Girouard & Christophe André, 2005. "Measuring Cyclically-adjusted Budget Balances for OECD Countries," OECD Economics Department Working Papers 434, OECD Publishing.
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    1. repec:mje:mjejnl:v:13:y:2017:i:3:p:135-148 is not listed on IDEAS
    2. Łukasz Rawdanowicz & Romain Bouis & Kei-Ichiro Inaba & Ane Kathrine Christensen, 2014. "Secular Stagnation: Evidence and Implications for Economic Policy," OECD Economics Department Working Papers 1169, OECD Publishing.
    3. Annabelle Mourougane & Jarmila Botev & Jean-Marc Fournier & Nigel Pain & Elena Rusticelli, 2016. "Can an Increase in Public Investment Sustainably Lift Economic Growth?," OECD Economics Department Working Papers 1351, OECD Publishing.
    4. Åsa Johansson & Yvan Guillemette & Fabrice Murtin & David Turner & Giuseppe Nicoletti & Christine de la Maisonneuve & Philip Bagnoli & Guillaume Bousquet & Francesca Spinelli, 2013. "Long-Term Growth Scenarios," OECD Economics Department Working Papers 1000, OECD Publishing.
    5. Boris Cournède & Antoine Goujard & Álvaro Pina, 2013. "How to Achieve Growth- and Equity-friendly Fiscal Consolidation?: A Proposed Methodology for Instrument Choice with an Illustrative Application to OECD Countries," OECD Economics Department Working Papers 1088, OECD Publishing.
    6. Jarmila Botev & Jean-Marc Fournier & Annabelle Mourougane, 2016. "A Re-assessment of Fiscal Space in OECD Countries," OECD Economics Department Working Papers 1352, OECD Publishing.
    7. Kuusi, Tero, 2014. "Consolidation under the Europe’s New Fiscal Rules: Analyzing the Implied Minimum Fiscal Effort," ETLA Working Papers 23, The Research Institute of the Finnish Economy.
    8. repec:mje:mjejnl:v:12:y:2017:i:3:p:135-148 is not listed on IDEAS
    9. Keränen, Henri & Kuusi, Tero, 2016. "The EU’s Fiscal Targets and Their Economic Impact in Finland," ETLA Working Papers 33, The Research Institute of the Finnish Economy.
    10. Falilou Fall & Debra Bloch & Jean-Marc Fournier & Peter Hoeller, 2015. "Prudent debt targets and fiscal frameworks," OECD Economic Policy Papers 15, OECD Publishing.

    More about this item

    Keywords

    assainissement budgétaire; dette souveraine; fiscal consolidation; fiscal rules; government budget balance; règle budgétaire; sovereign debt; équilibre budgétaire du gouvernement;

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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