How Delaying Fiscal Consolidation Affects the Present Value of GDP

IMF Working Papers, March 5, 2015

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The paper develops a simple model to examine conditions under which delaying fiscal consolidation can affect the present value of GDP via:
- the fiscal stance’s effects on the output gap, and
- hysteresis.
The model focuses on time-variation in fiscal multipliers and contrasts the multiplier during the initial period of fiscal stimulus with the multiplier when the stimulus is withdrawn.

The absolute size of the fiscal multiplier is "likely inconsequential" for the effect of delaying consolidation on the present value of GDP.
What matters is the degree to which the multiplier during the initial stimulus period differs from the multiplier when the stimulus is withdrawn.
If the multiplier is constant over time, delaying consolidation is unlikely to significantly boost the present value of GDP via effects on the output gap and hysteresis.
The potential success of delaying consolidation relies on exploiting time-variation in multipliers.

Policies that delay fiscal consolidation should be evaluated based on expected time-variation in fiscal multipliers rather than on the absolute multiplier value.
Efforts to raise the present value of GDP by postponing consolidation require conditions where multipliers are larger during the stimulus than when withdrawal occurs.

Authors: Kevin Fletcher, Damiano Sandri
Date: March 5, 2015
Series: Working Paper No. 2015/052
Issue: 052
Volume: 2015
Pages: 31
DOI: https://doi.org/10.5089/9781498393577.001
Stock No: WPIEA2015052
ISBN: 9781498393577
ISSN: 1018-5941
Subjects: Fiscal consolidation, Fiscal multipliers, Fiscal stimulus, Output gap, Public debt
Keywords: debt ratio, fiscal policy, interest rate, potential GDP, WP

Content based solely on "How Delaying Fiscal Consolidation Affects the Present Value of GDP", IMF Working Papers 2015, 052 (2015).