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Fiscal Consolidation Needs and Implications for Growth

Sutherland, Douglas (2012): Fiscal Consolidation Needs and Implications for Growth.

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Abstract

Public debt in the OECD area passed annual GDP in 2011 and is still rising. For many countries, just stabilising debt - let alone bringing it down to a more sustainable level - is a major challenge. The debt overhangs can affect growth through channels such as raising the cost of capital. The main focus of this paper however is the implications for growth both in the short term and in the long term of reducing debt levels. Consolidation needs are large and most of the reduction in debt will need to come from improvements in the primary balance. In the short term, the pace of consolidation needs to balance consolidation requirements with the effects of fiscal retrenchment on aggregate demand. The trade-off will depend on the choice of fiscal instrument and on the ability of monetary policy to accommodate consolidation. However, other things being equal, a slow consolidation will ultimately require more effort to meet a fixed debt target. In this context, consolidation should aim to use instruments that are friendly to long-term growth. There is scope to improve budgetary positions by reforming transfer systems, raising the efficiency of public services, eliminating certain tax expenditures and collecting additional revenues from less distortionary tax bases.

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