The Ins and Outs of Closing Fiscal Deficits

A range of well-respected economists, including Harvard economist Alberto Alesina whom I had pinned down as a Nobel candidate, just last week published an article (available here) that ought to cause some storm among academic economists. The snappy title of their paper on this politically-infected topic of fiscal policy is appealing enough: "Is it the 'How' or the 'When' that matters in fiscal adjustments?"

'Fiscal adjustments' is, of course, economists-speak for various kinds of policies intended to reduce public deficits, more commonly known as 'Austerity' policies. The standard talking point over the last half-decade or so has been how damaging such policies are for countries in recession or what government program to introduce instead. In their haste, the Krugmans of the world have of course forgotten to check their base premise; maybe austerity isn't a big deal, or – as even left-leaning economist have started to accept – there hasn't been much austerity in the first place. Here Alesina et al's article is a perfect match to light up the debate. 

This is the summary from their VOXeu article today:

When a government wants to cut a deficit, it must decide both how and when to do it. Research has treated the two questions as if they are independent, which risks attributing good policy to good timing, or vice versa. This column argues that when the effects are considered simultaneously, the composition of fiscal adjustments is much more important than the state of the cycle. Fiscal adjustments based upon spending cuts have losses that are on average close to zero, while those based upon tax increases are associated with large and prolonged recessions, regardless of whether or not the adjustment starts in a recession.

The take-home point is simply that 1) how is much more important than when, and 2) cutting spending really doesn't seem to hurt very much, whereas increasing taxes very much does:

We find that the composition of fiscal adjustments is more important than the state of the cycle in determining their effect on output. Fiscal adjustments based upon spending cuts are much less costly in terms of short run output losses – such losses are in fact on average close to zero – than those based upon tax increases which are associated with large and prolonged recessions regardless of whether the adjustment starts in a recession or not. …what matters for the short run output cost of fiscal consolidations is the composition of the adjustment. Tax-based adjustments are costly in terms of output losses. Expenditure-based ones have on average very low costs.

Adding to my growing reading list, I see. Maybe I should prioritise Alesina's work a bit more?