The Speed Limit of Fiscal Consolidation
Large fiscal adjustments are required around the world, particularly in the advanced economies
The large fiscal adjustment needed around the world will require a delicate
balancing act. Act too slowly and progress will be insufficient. Act too quickly
and the economy may stumble.
Countries are more likely to achieve sustained adjustments when initial
deficits are high and the adjustment focuses on spending cuts.
Consolidations are likely to act as a significant drag on growth regardless
of whether they focuson cutting spending or raising taxes and particularly
when not accompanied by monetary easing.
The extent of the growth drag will likely vary across countries, as adjustments
tend to be more painful in large, closed economies and countries with
fixed exchange rates.
The “speed limit” of fiscal adjustment—the pace of tightening after which
the corrosive impact on growth starts to undermine the fiscal position itself—
is therefore likely to be lower in large, closed economies (like the US or
Japan) and in countries with fixed exchange rates (European periphery)
than in small, open economies (UK).