Received Wisdom and Beyond: Lessons from Fiscal Consolidation in the EU

Abstract

Restoring sustainable public finances in the aftermath of the Great Recession is a key challenge in most EU countries. In order to learn from history, our paper examines consolidation episodes in the EU since 1970. We shed light on the factors that favour the start of a consolidation episode and determine its success. Compared to the existing literature, we add a number of new dimensions in the analysis. First, we explore a broader set of potential ingredients of the ‘recipe for success‘, including the quality and strength of fiscal governance and the implementation of structural reforms. Secondly, we check whether the ‘recipe for success’ changed over time. Our analysis broadly confirms received wisdom concerning the conditions triggering a consolidation episode and the role of the composition of adjustment for success, with some qualifications related to the role played by government wages. In addition it provides evidence that well-designed fiscal governance as well as structural reforms improve the odds of both starting a consolidation episode and achieving a lasting fiscal correction. We also show that, over time, successful and unsuccessful consolidation episodes have become more similar in terms of adjustment composition.

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