You are here: Home Knowledge Base The Design of Fiscal Consolidation Plans Virtual Library Fiscal Consolidation Strategy
Symposium 2015

Virtual Library File - Fiscal Consolidation Strategy

The Challenge

In the aftermath of the global financial crisis and the Great Recession, many countries are facing substantial deficits and growing debt. As analyzed in the 16th Geneva Report on the World Economy, th ...

In the aftermath of the global financial crisis and the Great Recession, many countries are facing substantial deficits and growing debt. As analyzed in the 16th Geneva Report on the World Economy, the global debt-GDP ratio continues to grow, while growth and inflation remain low, raising concerns about the dangers posed by new crises. This situation spurs the need to consolidate public finances in order to bring down debt-GDP ratios. When setting up specific fiscal consolidation plans in order to achieve this, policymakers can generally choose from a wide range of possible fiscal instruments. The aim of this session is to discuss how consolidation plans should be designed to bring debt-GDP ratios down, while minimizing short-run social and economic costs.


In this paper the authors analyze the effects of fiscal consolidation using a structural macroeconomic model. As the effects of fiscal consolidation are hard to identify empirically, this paper is a well suited to complement the two aforementioned empirical papers. The main finding is that government-spending-based consolidation has positive effects on output, both in the short run and in the long run. This occurs because:

  1. Lower levels of government spending in the future, compared to the baseline, imply lower tax rates, which provide better incentives and hence stimulate employment.
  2. The expectation of reduced government spending in the future lowers interest rates, which stimulates demand in a manner which offsets the decline in government spending in the short run.
  3. The lower interest rate reduces the exchange rate thereby increasing net exports, also offsetting the decline in government spending.