Front Matter Page

European I Department

Contents

• Summary

• I. Introduction

• II. Contractionary or Expansionary Fiscal Consolidations

  • 1. Keynesian effects

  • 2. Expansionary effects of fiscal contractions

• III. Fiscal Impulse: Cyclical Adjustment

• IV. Fiscal Adjustments in OECD Countries

  • 1. Definitions, sample, and basic statistics

  • 2. Success and composition

  • 3. Macroeconomic consequences of fiscal adjustments

  • 4. Sensitivity and comparisons with previous results

• V. Three Major Fiscal Adjustments

  • 1. The Irish adjustment 1987-89

  • 2. The Danish adjustment 1983-86

  • 3. The Italian adjustment from 1989

• VI. Conclusion

• Chart

• 1. Household Confidence Index

• Text Tables

• 1. Public Debt in OECD Countries

• 2. Tight Fiscal Policy: Primary Expenditures and Revenues

• 3. Successful Fiscal Adjustments

• 4. Successful and Unsuccessful Adjustments: Expenditures and Revenues

• 5. Successful and Unsuccessful Adjustments: Composition of Expenditure Cuts

• 6. Successful and Unsuccessful Adjustments: Composition of Expenditure Cuts as Share of Total Expenditure Cuts

• 7. Government Employment in Successful and Unsuccessful Adjustments

• 8. Successful and Unsuccessful Adjustments: Composition of Increases in Revenues

• 9. Successful and Unsuccessful Adjustments: Composition of Tax Increases as a Share of Total Tax Increases

• 10. Successful and Unsuccessful Adjustments: Macroeconomic Conditions

• 11. Successful and Unsuccessful Adjustment, Alternative Definition, Expenditures and Revenues

• 12. Successful and Unsuccessful Adjustments, Alternative Definition, Expenditure Cuts as a Share of Total Expenditure Cuts

• 13. Ireland: Fiscal Adjustment Size and Composition, 1987-89

• 14. Ireland: Macroeconomic Conditions and the Fiscal Adjustment, 1987-89

• 15. Denmark: Adjustment Size and Composition, 1983-86

• 16. Denmark: Macroeconomic Conditions and the Fiscal Adjustment, 1983-86

• 17. Italy: Fiscal Adjustment General Government, 1989-95

• 18. Italy: Fiscal Adjustment Central Government, 1989-95

• 19. Italy: Macroeconomic Conditions and the Fiscal Adjustment, 1989-94

• Appendix

• References

Summary

This paper discusses the contribution of the composition of fiscal adjustment to the sustainability of the adjustment and its macroeconomic consequences. First, the paper critically reviews theoretical arguments on the contractionary or expansionary effects of fiscal adjustments, including demand and supply-side considerations as well as the role of unionized labor markets. The paper next examines evidence for 20 OECD countries during the period 1960-94.

Two types of adjustments are identified. “Type 1” relies mostly on expenditure cuts—in particular, cuts in transfer programs and the government wage bill—and only to a small extent on tax increases. “Type 2” relies primarily on tax increases, with a lesser contribution from cuts in spending, mostly in the form of cuts in public investment. The paper shows that type-1 adjustments are more permanent and are expansionary, whereas type-2 adjustments do not lead to a long-lasting consolidation of the budget and are contractionary. This finding is attributed both to credibility effects and the superior supply-side effects of type-1 adjustments.

Finally, the paper examines in detail some cases of major fiscal adjustments: (1) Ireland during 1987-89, a case of a successful type-1 adjustment; (2) Denmark in 1983-86, a case somewhere in between a type-1 and a type-2 adjustment; and (3) the current Italian adjustment that started in 1989, clearly—at least until 1995—an example of type-2.