The Debate on Expansionary Fiscal Consolidation: How Robust is the Evidence?

Abstract

This paper critically examines the key empirical evidence used to support the fiscal consolidation argument, complemented by a brief assessment of the limitations of the analytical foundation of the growth promoting benefits of the fiscal consolidation thesis. It also reviews the evidence on the debt-growth relationship at some length. It finds that the negative relationship between debt and GDP growth is influenced by outliers or exceptionally high debt-GDP ratios. It also points out that the composition of public debt matters. Additionally the debt-GDP relationship appears to be non-linear-positive first and turning to negative, but there is considerable variation in the estimated turning or 'tipping' point, which is not helpful as a policy guide. Historical evidence does not lend support to the concerns that the current situation is likely to cause rapid upward spiraling of public indebtedness. Finally, the argument that fiscal consolidation is possible without adversely affecting growth is not based on robust empirical evidence. This conclusion is reinforced by a succinct overview of some country-specific experiences (Denmark, Ireland and United States).