WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

We present new evidence on the dynamic effects of fiscal consolidation shocks across different components of government spending. Based on data for 16 OECD countries over the 1995-2020 period, we use an instrumental variable approach that isolates exogenous fiscal tightening motivated by deficit reduction in a local projection framework. We find that fiscal consolidation shocks lead to sizable and persistent declines in public investment in the short to medium term, whereas reductions in government consumption are substantially smaller. Real expenditures on health, education, social protection, and environmental protection fall in response to fiscal tightening, albeit to varying degrees. We further show that the dampening effects of fiscal adjustment across spending categories depend on the macro-fiscal and political environment.