On the Output Effect of Fiscal Consolidation Plans: A Causal Analysis

Using data from 16 OECD countries over the period 1981-2011, this paper studies how different policy announcements affect economic growth in situations of fiscal consolidation. We focus on government announcements regarding reductions in expenditure and increases in taxation. We use a mediation analysis to uncover the direct and indirect effects elicited by such announcements. We find that during debt consolidation periods, announcements related to consolidation plans have no direct impact on GDP growth. However, spending cuts announcements have substantial negative indirect effects, resulting in overall negative total effects, while tax increases have negligible indirect and overall impacts. Our findings propose a new interpretation of the results of Alesina et al. (2015b): in terms of announcements, once accounting for indirect effects, spending cuts are more harmful to growth than tax hikes.