Abstract
Reducing the budget deficit is not easy. Keynesian theory suggests thatlowering government expenditures and raising revenues can lead to afalloff in economic activity. This paper argues the neoclassical approach - that a firm and credible reduction in expenditures, by engendering confidence that taxes will be less burdensome in the future,may lead to lower interest rates, boost consumption, and increaseinvestment spending.
leverage, currency depreciation, and spiking interest rates—contributed to the overall decline (figure). FCI Based on PCA (Standardized index,1994Q1-2014Q2) Sources: Central Bank of Iceland; Statistics Iceland; and IMF Staff calculations. 9. The recovery in financial conditions was impressive in 2010-11 but has stalled since then . A rebound in asset prices, a gradual private-sector deleveraging, a reduction in interest rates, and some currency appreciation lifted the FCI in 2010-11. However, since then, the recovery in financial conditions has stalled
different phases of the business cycle. This is achieved by repeating the previous exercise for the period 1980–81, a time of global recession and spiking interest rates, and the period 1984–89, a period of solid industrial country growth and flat or declining world interest rates. Clearly, it is difficult to reduce debt ratios in the midst of a global recession, especially if interest rates are increasing sharply at the same time. 17 None of the 7 efforts at fiscal consolidation over 1980–81, for example, including the highly visible efforts in the United Kingdom, were
, were more likely to succeed in reducing the public debt ratio than tax increases. Global Climate and Fiscal Adjustment . McDermott and Wescott note a discernible relationship between the world economic growth climate and the success of fiscal consolidation efforts. But the size and composition of the adjustment, they say, still seem to be the dominant determinants of the outcome, even when the world economy is booming. For instance, none of the seven consolidation efforts undertaken during 1980–81—a time of global recession and spiking interest rates—was successful
analyze this relationship is to examine fiscal adjustments over different phases of the business cycle. This objective is achieved by repeating the previous exercise, which was conducted over the full 1970–95 period, for the period 1980–82, a time of global recession and spiking interest rates, and the period 1984–89, a time of solid industrial country growth and flat or declining world interest rates. Clearly, it is difficult to reduce debt ratios in the midst of a global recession, especially if interest rates are increasing sharply at the same time. 16 None of the 7
efforts. Cause or Effect? Given the complex interactions between economic growth and changes in public debt ratios, it is difficult to distinguish between the contribution of growth to successful fiscal consolidations and the contribution of successful consolidations in boosting growth. One way to analyze this relationship, however, is to examine fiscal adjustments during different phases (recession or expansion) of the business cycle. None of the seven efforts at fiscal consolidation during 1980–81, a period of global recession and spiking interest rates, was