Fiscal multipliers and the risk of self-defeating fiscal consolidation: Evidence for the Italian economy

Abstract

In this paper we document the fiscal multipliers for the Italian economy and show how their size impinges on the degree of success of a fiscal consolidation. To this aim, we use the econometric model of the Italian Treasury (ITEM). By simulating a number of alternative fiscal policy impulses on both the public expenditure and the revenue side, we derive the corresponding dynamic fiscal multipliers and ascertain the impact of these measures on the primary indicator of public finance performance, namely the debt-to-GDP ratio. We find that a shock on the expenditure side yields effects on output that are more pronounced in the short term and tend to vanish in the medium-to-long run. Conversely, the effects of shocks on the tax side are more persistent and become larger in the medium run. We therefore show that if a fiscal consolidation is channeled on the expenditure side, then it is in general self-defeating in the short run, as the debt-to-GDP ratio is shown to deteriorate for some years. Conversely, if the fiscal consolidation is channeled on the revenue side, then the debt-to-GDP ratio improves, although by significantly less than the ex-ante size of the fiscal correction.