Fiscal consolidation as a policy strategy to exit the global crisis

Giancarlo Corsetti 17 June 2010



The Greek crisis has so far been treated as a Eurozone problem. However, fiscal consolidation is now a global issue, and should be understood in the context of the policy reaction to the global crisis. This essay emphasizes two dimensions of debt consolidation during early phases of the recovery from deep recessions.

  • The output costs of spending cuts today might be substantial if the financial crisis continues, but
  • The benefits from commitment to gradual implementation of deficit cutting measures in the future are important.

Asymmetric multipliers

As the world economy is still undergoing financial stress, the withdrawal of the fiscal stimulus (via a reversal of previous spending and tax measures) has an economic cost. There are reasons to believe that this cost is not low.

According to Reinhart and Rogoff (2008), an economy in the throes of a financial and banking crisis is especially sensitive to government spending. Unexpected changes in such stimulus have big affects on output, consumption, and investment – much more than the mechanical one-to-one boost. In my own research, I find the impact multipliers for government spending on goods and services are usually quite low in normal circumstances but they become high – as high as two for output and consumption – during financial and banking crises (Corsetti et al. 2010b). Policymakers should keep these asymmetries in mind. Macroeconomics works differently in crisis and non-crisis periods.

These results call for a countercyclical approach to fiscal policy. Buffers should be built up in good times so as to avoid forced contractions in bad times when the cost of a contraction is asymmetrically high. For the Eurozone today, these results offer a warning about the macro costs of sharp cuts in government deficit. The crisis, after all, is not over yet.

How should fiscal consolidation proceed?

While fiscal consolidation is a common goal, the appropriate strategy to pursue it may not be the same across countries. In some cases, a sharp correction is obviously called for in response increasing risk premia paid on government debt. Failure to consolidate would not only raise the cost of borrowing for the government; it would also undermine macro stability with widespread economic costs. In this case, immediate cuts in spending and tax hikes may be useful in signalling the government commitment to consolidation.

Yet the extent and credibility of corrections will be mainly judged by their sustainability, and their budget effects, in the medium to the long run.

Given the size of the public debt, it is unlikely, if not unwise, to place the whole burden of the correction on higher taxes. On the contrary, experience shows that most successful debt consolidations depend on a government ability to cut, or at least contain, spending.

A gradual implementation of spending cuts has several desirable effects (see Corsetti et al. 2010a). While this research is still ongoing, it suggests that steady but gradual consolidation may be the strategy that has the lowest cost in terms lost output. Cutting too much today could be throw us back into a recession, but cutting too slowly may heighten panic in the markets for government debt.


As financial markets are still fragile in Europe and elsewhere, policymakers face a challenging task. Failure to reassure financial markets about debt sustainability would bring back the unstable market conditions seen this Spring. This requires immediate action. However, the immediate action can be more than immediate budget cuts and tax hikes.

The key to maintaining market confidence is a plan that puts government debt on a sustainable path. And debt sustainability does not depend mainly on quick corrections with limited effects in the near future – however, important such moves may be as signals of the government’s determination on fiscal discipline. Sustainability requires policies with lasting effects on the budget, reducing the medium- to long-run budget risk.


Christiano, Lawrence, Martin Eichenbaum, and Sergio Rebelo. 2009. “When is the government spending multiplier large?” NBER Working Paper 15394.

Corsetti, Giancarlo, Keith Kuester, Andre Meier and Gernot Mueller. 2010a. “Debt Consolidation and Fiscal Stabilization of Deep Recessions.” American Economic Review, May.

Corsetti, Giancarlo, Andre Meier and Gernot Mueller. 2010b. “What determines government spending multipliers?” mimeo.

Reinhart, Carmen and Kenneth Rogoff. 2008. “Banking crises: An equal opportunity menace.” NBER Working Paper 14587.



Topics:  Global crisis

Tags:  fiscal consolidation, Fiscal crisis, Eurozone crisis, Eurozone rescue

Professor of Macroeconomics, University of Cambridge


CEPR Policy Research