Using regime-switching VARs, IMF estimates the impact of fiscal adjustment on the United States, Europe and Japan allowing for fiscal multipliers to vary across recessions and booms.
The output effects of 2009 fiscal expansions have been hotly debated. But the discussion of fiscal multipliers is even more relevant now that several European countries have had to retract quickly their stimulus measures in an effort to regain market confidence.
IMF estimates ex ante probabilities of recessions derived in association with different-sized and different types of consolidation shocks (expenditure- versus tax-based). It uses these estimates to understand how consolidations should be designed to be most effective in terms of permanently and rapidly reducing a country’s debt-to-GDP ratio.
The main finding is that smooth and gradual consolidations are to be preferred to frontloaded or aggressive consolidations, especially for economies in recession facing high-risk premia on public debt, because sheltering growth is key to the success of fiscal consolidation in these cases.
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