Understanding the long-term effects of fiscal consolidation on economic growth

Abstract

The long-term effects of fiscal consolidation on economic growth represent a critical and deeply contested area in macroeconomic policy. This article contends that these effects are not monolithic but are fundamentally contingent upon the specific design and context of the austerity measures. While theoretical frameworks suggest potential long-term benefits through channels such as reduced crowding out of private investment and enhanced business confidence, these are often counterbalanced by the significant risks of hysteresis, whereby temporary output losses become permanent through the erosion of human capital and productive capacity. The analysis underscores that the composition of fiscal adjustment is a paramount determinant of its growth impact; expenditure-based consolidations, particularly those safeguarding public investment, are generally found to be less detrimental to long-term growth than those reliant on distortionary tax increases. Furthermore, the macroeconomic context at the outset - including the business cycle position and available monetary policy space - and the presence of complementary structural reforms are identified as crucial mediating factors. Ultimately, the article concludes that the trajectory of economic growth following fiscal consolidation is not preordained but is shaped by a complex interplay of policy choices, initial conditions, and institutional settings, moving the debate beyond a simplistic trade-off towards a more nuanced understanding of fiscal sustainability.