2.2. Threshold of Fiscal Consolidation
Alesina and Perotti (
1995) defined the success of fiscal consolidation as changes in fiscal policy that are very tight, resulting in a gross debt share to GDP threshold that is 5% lower than the initial time. There were 66 successful fiscal episodes from 20 OECD countries between 1990 to 1992, and 14 episodes were very tight.
Blanchard (
1990) filtered out the cyclical movement to find a dictionary change that can be attributed to fiscal consolidation. Using a vector autoregressive (VAR) model, 14 OECD countries from 1970 to 1985 it was found that in very tight years, taxes increased by 1.2% of GDP, and spending was cut by 0.79% of GDP. The success of fiscal consolidation is possible when implemented mainly through government expenditure cuts.
Giavazzi and Pagano (
1995) used a definition approach in 20 Europe countries from 1970 to 1990, fiscal consolidation is deemed when there is a cumulative change in the CAPB that is at least 5%, 4%, and 3% points of GDP in years 4, 3, and 2. They found 223 fiscal consolidation episodes using this definition. It was noted that countries in the 1990s were adopting government expenditure cuts and tax increases to reduce the government debt ratio to gross domestic product. The definition of a fiscal consolidation episode by
McDermott and Wescott (
1996) was based on the threshold of a 1.5% increase in GDP over 2 years in 21 OECD countries from 1970 to 1995. There were 74 episodes based on revenue increases and 34 based on expenditure cuts. In a probit model, it was found that government expenditure cuts of government wages result in a 3.22% fall in government debt. These results suggest that government expenditure cut-based fiscal consolidations are more likely to be successful in reducing government debt. The CAPB threshold of a 2% or 1.05% increase in the share of GDP for two consecutive years by
Alesina et al. (
1998) in 18 OECD countries from 1965 to 1995 was undertaken as the rationale in the effort to define fiscal consolidation episodes. The fiscal consolidation was deemed to be successful if the primary deficit had a threshold that was 2% below the GDP in the year of the tight policy. Using these thresholds, the authors found 51 fiscal consolidation episodes, 19 of which were deemed to be successful, while 23 had an expansionary effect on economic activities in OECD economies characterized by low unemployment.
Duperrut (
1998), in South Africa from 1973 to 1997, fiscal adjustments were defined as a one-year improvement in the primary balance of the general government of more than 1.5% of GDP. It was found that there are episodes with two successfully representing 22.22% success. If the fiscal adjustment is of reasonable size, there is between a 1.5% and 2% negative impact on GDP.
Hansen (
2000), authors defined the success of the fiscal adjustment when the CAPB threshold improves by 2.5% or there is an improvement by 2% for at least two consecutive years in 18 OECD from 1980 to 1998. It was found that there are 39 fiscal consolidation episodes. The authors used the OLS model and found a 4.55% fall in government debt share to GDP in the representation of fiscal consolidation programs in OECD countries. Contrary to (
Alesina and Ardagna 2010;
McDermott and Wescott 1996), fiscal adjustments through the increase in taxes were found to contribute to the reduction of government debt.
Zaghini (
2001) identified the fiscal consolidation episode and the CAPB increase with thresholds of 1.6% or 1.4% in 14 European countries from 1970 to 1998. The author found 100 fiscal consolidation episodes, of which 52 were characterized by a more expansionary fiscal contraction effect, while 48 were loose policy interventions. Using the VAR model, government debt increased by 3.7% with no fiscal consolidation intervention.
Purfield (
2003), fiscal adjustments and successful fiscal episodes were selected if there was a threshold of a 2% fall in government debt share to GDP in one year in 24 countries from the Soviet Union (FSU) and Eastern Europe (CEE) from 1992 to 2000. There were 33 fiscal adjustments with 27 fiscal consolidations based on government expenditure cuts. The VAR showed that a 1% fall in government expenditure cut resulted in a 2.3% increase in real GDP growth. However, a 1% increase in government tax results was found to result in a 2.1% increase in real GDP growth.
Gupta et al. (
2005), fiscal consolidation episodes were selected if the CAPB improved by the threshold of 1.25% of GDP for two cumulative years in 15 emerging economies from 1990 to 2000. It was found that fiscal consolidation lacked a positive impact on economic growth. However, the authors pointed out that the CAPB cannot identify the discretionary fiscal policy.
Afonso et al. (
2006), fiscal consolidation was identified if government debt falls by the threshold of 2%, and then the dummy variable was used. The authors found 114 and 20 successful fiscal consolidation episodes from 1990 to 2004. The logit model provided evidence that government expenditure-based fiscal consolidation results in a 4.2% fall in government debt.
Ardagna et al. (
2007), authors defined fiscal adjustment as when CAPB improves a threshold of 1.5% and after 2 years government debt shares to GDP fall in 17 OECD countries from 1960 to 2002. The Logit model was adopted, and it was found that with a 1% increase in government expenditure cut and a tax increase, there is a 0.27% and a 0.30% chance of the fall in government debt share to GDP, respectively. Similar to (
Afonso et al. 2006;
Gupta et al. 2005;
McDermott and Wescott 1996;
Zaghini 2001), it was found that fiscal adjustment through government expenditure cuts leads to higher GDP growth rates than tax increases.
Morris and Schuknecht (
2007) adopted the VAR model, and fiscal consolidation episodes were selected when the CAPB increased by the threshold of 1.25% of GDP for two years in 16 OECD countries from 1960 to 2005. It was found that a 1% increase in CAPB results in a 0.6% increase in structural budget balance as a share of GDP. The author outlined that the CAPB has significant shortfalls of influence coming from cyclical changes. Contrary to (
Alesina and Perotti 1995;
Blanchard 1990) and (
Gupta et al. 2005), the authors proposed that both short and longer asset prices need to be accounted for in the cyclically adjusted balance.
Alesina and Ardagna (
2010) used the definition of fiscal consolidation when there is a CAPB threshold of 1.5% of GDP in OECD countries similar to that of (
McDermott and Wescott 1996). They found 107 periods of fiscal adjustments, which represented 15.1% of the observations, and 91 periods of fiscal stimuli, which were 12.9% of the observations in a sample from 1960 to 1994. It was also found that fiscal adjustments based upon spending cuts and tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases.
Barrios et al. (
2010) used the fiscal consolidation episode definition adopted from the
Alesina and Perotti (
1995) and
Alesina and Perotti (
1997) criteria. The data reflected 235 fiscal consolidation episodes, the probit model was used, and it was found that there is a 30.3% and 24.4% chance that government debt will be lower than usual during the financial crisis and post-financial crisis in the presence of fiscal consolidation, respectively. Such results indicated that countries must have an effective model to implement fiscal consolidation in times of fiscal distress to increase the chances of success.
Romer and Romer (
2010) and
Devries et al. (
2011) investigated fiscal consolidation from 1947 to 2006. They note that when fiscal consolidation is defined with the use of CAPB. This may lead to biased results since the CAPB is subjected to changes in the cyclical component. When the cyclical component is not accounted for, the CAPB may not be effective in finding fiscal consolidation or discretional action by fiscal authorities toward reducing government debt. As such,
Romer and Romer (
2010) and
Devries et al. (
2011) proposed that there is a need to go to a government document and extract where it is said there will be a cut in government expenditure and tax increase and take that a fiscal consolidation.
Tagkalakis (
2011), asset price impacts the CAPB. Using the VAR model, it was found that a 1% increase in asset prices results in 0.056% in government expenditure in 17 OECD countries from 1970 to 2005. This reflects that the CAPB may have the weakness of being affected by cyclical components such as asset prices. Similar to
Tagkalakis (
2011),
Perotti (
2012) investigated austerity and noted that CAPB has two possible limitations, namely, cyclical adjustments and asset price influence, which the author refers to as imperfect cyclical adjustment problems. Moreover, there are limitations when the CAPB is correlated with cyclical changes. The author concluded that the narrative approach of
Romer and Romer (
2010) and
Devries et al. (
2011) is better to avoid the above limitation note above, but the cyclically adjusted balance is flawed by both.
Aizenman et al. (
2012) found in the VAR model that an increase in a value-added tax increase as an influence of fiscal consolidation reduces output.
Perotti (
2012) used the narrative approach advocated by
Romer and Romer (
2010) to find fiscal consolidation. Similar to
Aizenman et al. (
2012), it was found that VAT results in a fall in economic growth.
Amo-Yartey et al. (
2012) adopted a logit model as used by
Afonso et al. (
2006) and used economic data from CAPB. Fiscal consolidation was defined as a 1% improvement in CAPB in year one. They found 206, 107 similar to
Alesina and Ardagna (
2010), and 51 episodes of government debt share to GDP reduction. Fiscal consolidation increased the likelihood of government debt share to GDP reduction by 0.58%.
Amo-Yartey et al. (
2012) study demonstrates that significant debt reductions are linked to robust economic growth and effective and long-lasting fiscal consolidation initiatives from 1980 to 2011 in the Caribbean. Since growth is essentially nonexistent in the current context, severe budgetary austerity is unavoidable in the area. The obvious areas to cut back on spending include the public wage bill, public sector efficiency, and transfer payments. On the revenue side, there is plenty of potential for tax spending cuts, distortion elimination, and tax base expansion. To increase competitiveness, a comprehensive debt reduction strategy that includes changes to tax laws and structural reforms is required to go along with fiscal austerity.
Heylen et al. (
2013) built upon the scope of
Heylen and Everaert (
2000) and argued that changes in the government debt share to GDP between the range of 10% and 25% cannot be limited to either ‘success’ cases or ‘failures’, as there is a need to explain such outcomes. They found the change in the government debt share to GDP to vary between −25% and 35%. The OLS model was used, and it was found that a 1% increase in government efficiency increases the expansionary fiscal adjustment variable by 2.55%.
Alesina and Ardagna (
2013) identified the threshold of fiscal consolidation episodes to be successful if the debt-to-GDP ratio falls for two years after fiscal adjustment. This definition found 25 fiscal consolidation episodes of successful fiscal adjustments and 24 unsuccessful ones in 21 OECD countries from 1970 to 2010. This definition selects 35 episodes of expansionary fiscal adjustments and 17 contractionary adjustments.
Heylen et al. (
2013), used the definition of
Alesina and Ardagna (
2010) and the narrative definition of
Devries et al. (
2011) in 21 OECD countries. Using the panel instrument variable (IV) model, fiscal consolidation was found to be successful in reducing government debt.
Yang et al. (
2015) investigated the macroeconomic effects of fiscal adjustment using two approaches: the narrative and CAPB from 20 OECD countries from 1970 to 2009. In response to the estimation challenges of CAPB, they considered the asset price as mentioned by
Romer and Romer (
2010) and
Devries et al. (
2011). The authors account for asset price movement and remove its cyclical effect on government revenue. Moreover, contrary to the literature, they used the standard deviation in the fiscal consolidation definition to account for country-specific heterogeneity. They defined fiscal adjustment episodes as CAPB increases of 0.33 points of the mean and standard deviation for two and three years or more. There were 66 fiscal episodes, 11 of which lasted for one year, and the overall period of the 66 fiscal episodes was 19 years, with most of the countries having implemented fiscal consolidation for 9 years. The adopted panel Logit model found that expansionary fiscal adjustments result in a 28.9% likelihood of a decrease in economic growth. However, the lagged effect of such changes provides a 15% chance of an increase in the impact on economic growth. They then concluded that there is no clear evidence of the effect of fiscal consolidation.
Wiese et al. (
2018) result shows that the effectiveness of fiscal changes is unrelated to their composition in 20 OECD countries from 1965 to 2015. With one exception, we show that political-economic variables are not strongly associated with effective fiscal adjustments. If left-wing governments concentrate on spending reductions and right-wing governments rely on tax hikes, the likelihood of a successful fiscal adjustment will rise.
Arestis et al. (
2018) note that debt sustainability hinges on the stability of the debt-to-GDP ratio other than fiscal consolidation.
David and Leigh (
2018) investigated a new action-based dataset of fiscal consolidation in Latin America and the Caribbean (LAC) using
Romer and Romer (
2010) definition of fiscal actions using a narrative approach. The rationale was to find discretionary changes in taxes and government spending primarily motivated by a desire to reduce the budget deficit and long-term fiscal health and not by a response to prospective economic conditions. The author examined contemporary policy documents, including budgets, central bank reports, and IMF and OECD reports. Based on this approach, it was found that there are 76 fiscal policy adjustments in 14 LAC economies. It was found that fiscal consolidation consisted of 0.9.
Afonso and Silva Leal (
2019) assess how fiscal elasticities vary during fiscal episodes in 20 OECD countries from 1970 to 2015. According to the results, positive “tax revenue” elasticities indicate that consumers have Ricardian behaviour. There were 182 found using the narrative approach and the threshold of 1.5% CAPB. There was an 18.61% chance of success of fiscal consolidation.
Agnello et al. (
2019) findings demonstrate that disparities in the duration and success/failure of fiscal consolidations are explained by economic and political factors, the amount and typology of fiscal adjustments, and the incidence of crises in 10 OECD countries from 1980 to 2010. Moreover, fiscal adjustment programs that succeed show a positive length dependence.
Aye (
2019) employed the narrative technique to measure fiscal consolidations in 14 Organization for Economic Co-operation and Development (OECD) nations between 1978 and 2014, using the criterion of a 2% change in the CAPB. It was discovered that tax hikes had little effect on public approval of the government, but spending cuts have the opposite effect, especially during economic downturns.
Nunes (
2019) in OECD nations between 1978 and 2017 noted that public spending before a fiscal consolidation has a positive effect on the likelihood that the fiscal consolidation will be successful; that is, the more public spending occurs in the year before a fiscal consolidation, the more likely it is that the fiscal consolidation will be successful, assuming all other factors remain constant. This finding may be consistent with the literature’s finding that expenditure-based fiscal consolidations are more likely to be successful.
Glavaški and Beker-Pucar (
2020) investigated episodes of fiscal using the autoregressive distributed lag (ARDL) model from 1950 to 2018. It was found that the cyclically adjusted primary budget balance in GDP increases by 1%, and the real economic growth in western China will grow by 0.26%. This means that fiscal consolidation has a positive impact on economic growth in this region.
de Rugy and Salmon (
2020) investigated large fiscal consolidations in 26 countries from 1995 to 2018 and found 35 fiscal consolidation episodes. There were 62 successful consolidations found and 73 unsuccessful consolidations. They found that there were 45 expenditure-based fiscal consolidations (EB) episodes, and more than half were successful, while there were 67 tax-based fiscal consolidations (TB) episodes in which less than 4 in 10 were successful.
Deskar-Škrbić and Milutinović (
2021) results indicate that the fiscal consolidation implemented during the excessive deficit procedure is not growth-friendly and that it was partially self-defeating. This result was found in Croatia using the data from 1975 to 2018.
Xiang et al. (
2021) use the definition of
Alesina and Perotti (
1995) and
Alesina and Perotti (
1997) for fiscal consolidation in 13 Latin America. They found 51 fiscal consolidation episodes in 13 LAC countries. Using the panel multiple regression model, it was found that on average, these fiscal consolidation episodes have a statistically significant negative impact on total factor productivity (TFP). Moreover, they noted that in fiscal consolidation policies, expenditure cuts are a better policy option than tax increases, which agrees with the popular opinion in this field of research.
Afonso et al. (
2022a) investigated the non-Keynesian effects of fiscal austerity using different definition approaches from
Alesina et al. (
1998),
Giavazzi and Pagano (
1995), and
Afonso and Jalles (
2013). It was found that there are 122 episodes. Fiscal consolidation of tax increases has a positive effect on private consumption in the presence of fiscal consolidation.
Bamba et al. (
2020) found that fiscal consolidations significantly reduce the government investment-to-consumption ratio in 56 developed and emerging countries from 1975 to 2018. They define fiscal consolidation if the ratio CAPB/GDP improves each year, and the cumulative improvement is at least 2% to 3%. It was found that 52.85% were tax-based and 30.89% were expenditure-based. In 18 countries of the Euro area over the year 1999 to 2017,
Carnazza et al. (
2020) proposed a way to dispense with the estimation of potential GDP and, therefore, of the NAWRU to compute the CAPB and simultaneously focus only on the budgetary items, both revenues and expenditures, that automatically react to the business cycle. The idea is to choose the budgetary items whose cyclical component is significantly correlated with the cyclical component of GDP.
Giesenow et al. (
2020) found that the frequency and duration of fiscal adjustments and expansions are influenced by political and institutional factors using the annual data for 60 countries from 1980 to 2014. The findings further emphasize how crucial it is to consider both the likelihood and durability of fiscal events.
Ardanaz et al. (
2020) found 42% and 41% of the tax base as well as expenditure-based fiscal consolidation in Latin America from 1985 to 2018. Moreover, fiscal consolidations do not have significant electoral consequences.
Kalbhenn and Stracca (
2020) noted that an increase in the CAB takes place with a public debt-to-GDP ratio already above 90% of GDP. This was using the 26 European Union countries on annual data between 1997 and 2017. Moreover, the authors found that economic agent opinion and credibility matter for the success of fiscal consolidation. In 14 European Union countries over the period 1970 to 2019,
Quaresma (
2021) combine the narrative technique with the standard CAPB method for identifying fiscal consolidations and extends this method to incorporate dummy variables for identifying monetary expansions. Few non-Keynesian effects are evident when fiscal consolidation is coupled with monetary expansion; therefore, monetary expansions do not necessarily explain the occurrence of expansionary fiscal consolidations.
Afonso et al. (
2022b) used the WEO-based CAPB, which is the world economic outlook data based on the International Monetary Fund (IMF) with a sample of 174 countries between 1970 to 2018. They applied the approach of a 1.5% increase in the CAPB to the identification of fiscal consolidation episodes. It was a fiscal consolidation program that implies an improvement in the degree of public financial sustainability in advanced and developing economies.
Kopecky (
2022) note that spending reductions and tax increases have different effects on demographics, with significant differences occurring between dependent and working-age groups in 17 OECD countries. When using
Devries et al. (
2011) data set
Kopecky (
2022) found that tax hikes result in a reduced output response in economies that are still developing, a stronger reaction as population weights shift toward middle age, and a falling response when there are high proportions of retirees. Using panel data of 73 countries over the 2003 to 2013 period
Gootjes and de Haan (
2022) note that fiscal laws increase the likelihood that fiscal changes will be successful, but only when there is enough transparency. These results seem to be highly resistant to the inclusion of contextualizing variables that might affect the effect of fiscal regulations and budget transparency. However, it is crucial to take into consideration the volatility of fiscal policy to identify the impact of fiscal laws on fiscal adjustments.
In panel of 21 emerging market and developing economies (EMDEs) from 2000 to 2018 by
David et al. (
2022) note that in the counterfactual scenario when spreads do not react to announcements, production is reduced by 30%. These findings demonstrate that a crucial conduit for the transmission of changes in fiscal policy is confidence impacts, which manifest as lower sovereign spreads. Furthermore, the importance of confidence effects grows with spread levels. Therefore, countries with high spread levels stand to gain the most from implementing credible austerity measures.
Table 2 shows the summary of fiscal consolidation episodes used by different scholars in the effort to find fiscal consolidation episodes.
In the data set from 1970 and 2018 in the effort to determine fiscal consolidation episodes
Afonso and Silva Leal (
2022) used the narrative approach and 1.5% CAPB production and import taxes to show a non-Keynesian response in countries with debates below 60% of GDP, negative output gaps, and during recessions in 17 OECD countries. Primary expenditure shocks might have negative effects on GDP during expansions. In 23 emerging and middle-income countries for the 2009 to 2018 period,
Lahiani et al. (
2022) outline that the improvement of the current account and fiscal consolidation will eventually help to stabilize foreign debt over the medium and long term. However, excluding important growth drivers such as human capital can result in numerous inefficiencies, including a lack of competition in the delivery of social services.
Buthelezi and Nyatanga (
2023), investigated the time-varying elasticity of cyclically adjusted primary balance and the effect of fiscal consolidation on domestic government debt in south Africa. Using the time-varying parameter vector autoregression (TVP-VAR) it was found that CAPB with time-varying parameters better captures the fiscal consolidation that constant elasticity of the CAPB It was found that the shock of macroeconomic uncertainty harms economic growth.
Georgantas et al. (
2023) highlight the importance of timing for fiscal policy adjustments. The authors argue that adjustments based on spending that are made during recessions, times of tight money, or when the debt-to-income ratio is higher than 80% are counterproductive. During recessions, cutting government spending can have negative effects on economic growth and job creation. This is because government spending helps to stimulate demand and boost economic activity. Similarly, during times of tight money, cutting government spending can lead to a further contraction in credit markets and reduce private investment. Additionally, when the debt-to-income ratio is high, cutting government spending can lead to a vicious cycle of lower growth, lower tax revenue, and higher debt levels. This is because lower government spending can lead to lower economic growth, which in turn reduces tax revenue and increases the debt-to-income ratio. On the other hand, fiscal consolidations initiated during expansions, in low-debt nations, during times of loose monetary conditions, and in open economies can be expansionary and result in a more pronounced fall in the debt ratio. During expansions, cutting government spending can help to reduce inflationary pressures and prevent overheating in the economy. In low-debt nations, cutting government spending can lead to increased confidence among investors and reduce the risk of a debt crisis. During loose monetary conditions, cutting government spending can offset the inflationary effects of easy monetary policy.
Buthelezi (
2023a) investigated the macroeconomic uncertainty on economic growth in the presence of fiscal consolidation in South Africa from 1994 to 2022. It was found that macroeconomic uncertainty’s negative impact on economic growth is reduced when there is an adoption of fiscal consolidation.
Buthelezi (
2023b) investigated the impact of government expenditure on economic growth in different states in South Africa. It was found that government expenditure increase economics growth. However, the study was silent on the role of fiscal consolidation on economic growth in South Africa. Nevertheless, this study suggests that there are times in the economy when fiscal consolidation my not the relevant. This is back positive effect of an increase in government expenditure on economic growth, while fiscal consolidation advocates for a decrease in government expenditure.