IMF research warns short-term fiscal consolidation pain could become more serious

Policy-makers need to pay more attention to fiscal multipliers to avoid "unpleasant surprises", according to a working paper published by the IMF.

In The Challenge of Debt Reduction during Fiscal Consolidation, authors Luc Eyraud and Anke Weber study the impact of fiscal consolidation on debt dynamics. They find that fiscal tightening may have a short-run negative impact on the deficit as output falls, but debt starts to fall in the longer run.

However, the authors warn the impact on growth could be amplified if there is a negative reaction in financial markets, or if the short-term failure of consolidation to reduce the deficit leads policy-makers to overcompensate and cut too much.

"These findings do not imply that fiscal consolidation is undesirable or that debt is unsustainable," the authors stress. "Our results rather highlight the need for care in projecting the debt path and the benefits of setting and monitoring debt targets in cyclically-adjusted terms."