Thursday, April 15, 2010

Why is growth stronger in expenditure-driven corrections?

Interesting recent paper;

Goldman Sachs Global Economics, Commodities and Strategy Research- Limiting the Fall-Out from Fiscal Adjustment (via Irish Economy blog)

In a review of every major fiscal correction in the OECD since 1975, we find that decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth....

In a landmark paper in the mid-1990s, the economists Alberto Alesina and Roberto Perotti found that economic growth fared much better during large fiscal corrections that were (i) decisive rather than gradual and (ii) relied on reductions in current government spending, rather than cuts in public-sector investment or higher taxes.

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