Revenue- versus spending-based consolidation plans : the role of follow-up

Author / Creator

Beetsma, Roel M. W. J., author

Available as

Online

Summary

The literature presents evidence that spending-based fiscal consolidations tend to have more benign macro-economic consequences than revenues-based consolidations. Several explanations have been pu...

The literature presents evidence that spending-based fiscal consolidations tend to have more benign macro-economic consequences than revenues-based consolidations. Several explanations have been put forward. By directly comparing ex-post data with consolidation plans, we offer a new explanation based on robust evidence of systematically-weaker follow-up of spending-based consolidation plans. Systematically over-optimistic growth forecasts can explain a substantial part of the differences in follow up. Next, using a newly developed dataset on consolidation announcements, we indeed confirm that follow-up in actual revenues is substantially better than in actual spending and that, consistent with a Keynesian setting, spending-based consolidations produce more benign macro-economic effects. An advantage of our dataset is that we control for confidence effects that can occur immediately after new fiscal information becomes available. Consistent with the ensuing course of the economy, confidence falls (is unchanged) upon announced revenue increases (spending reductions). Under a counterfactual in which the confidence channel is suppressed, announcements of revenue-based consolidations have a substantially less negative effect on the economy.

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