Cross-country spillovers from fiscal consolidations

In many OECD countries, government debt reached levels over recent years that call for reduction over the medium to longer term to ensure public finance sustainability. This paper investigates the international transmission of fiscal consolidation shocks via trade flows. Using a measure of exogenous fiscal shocks in export markets, fiscal consolidation spillovers are found to slow domestic growth and decrease employment. When fiscal consolidation efforts are synchronised across partner countries, fiscal policies have large spillover effects on output. Spillovers of fiscal consolidations on growth are found to be initially larger between countries belonging to currency unions, though this larger impact vanishes over the medium term. Larger spillovers of fiscal consolidation coincide with stronger shifts in bilateral trade flows in currency unions in the short term, despite smaller adjustments in relative exchange rates. Spillovers of fiscal consolidation are also found to be more detrimental to domestic growth during economic downturns in export markets.