From Alberto Alesina, Carlo Favero, and Francesco Giavazzi, through Greg Mankiw’s blog, new research considers the effect of fiscal corrections on output losses, attempting to determine whether spending and tax based fiscal reforms have a significantly different effect on future output from one another. The paper concludes that:
“Allowing for cross country heterogeneity in the style of fiscal adjustments delivers estimates which are much more precise than those obtained studying the effects of individual fiscal shocks within an aggregate cross country analysis. The key result is that while expenditure-based adjustments are not recessionary, tax-based ones create deep and long lasting recessions.”
Additionally that:
“The differences between the two types of adjustments appears not to be explained by a different response of monetary policy.”
Though such research cannot fully explain or diagnose an ideal prescription for a country’s fiscal problems, it does shed interesting light on the fiscal debate. When political rhetoric and debate is introduced to the fiscal policy conversation, the solution becomes even more convoluted. If spending cuts cause economic difficulties, even if only in the short run, politicians approaching election years may be more reluctant to adopt such cuts for fear of angering constituents. Such potential conflict of interest increases the difficulty in instituting effect reforms consistent with empirical data and evidence.
