Fiscal consolidation and political instability

This paper analyses how fiscal consolidation shocks affect political instability in advanced economies. Using data on fiscal tightening in 17 OECD countries from 1980 to 2020, we estimate dynamic effects in a local projection framework employing a narrative-based instrumental variable approach that isolates exogenous fiscal changes motivated by deficit reduction. Fiscal consolidation carries substantial short-term political costs it lowers government approval and increases the likelihood of protests and major government crises. These effects are temporary and dissipate over time. The decline in government approval is largely accounted for by the deterioration in macroeconomic conditions following fiscal adjustment. Consistent with this mechanism, consolidations implemented during economic downturns lead to markedly larger declines in approval and a higher probability of government crises, while effects are muted in stronger economic conditions. Turning to the tax-spending composition, we find that approval declines more sharply when adjustments only rely on spending cuts. Overall, our findings provide new evidence on the political costs of fiscal tightening and point to the importance of economic conditions and policy design.