Critical thresholds for budget consolidations: a semi-parametric approach

Abstract

While a lot is known regarding the determinants of successful fiscal consolidations, previous studies do not allow for the possibility of nonlinearities in factors impacting budget consolidations. By using a semi-parametric modelling approach employing penalized spline regression on a data-set for 28 OECD countries for the period 1978–2007, we demonstrate the existence of critical thresholds not only for the initial debt level but also for the accompanying monetary policy. The latter result shows when monetary policy matters most and suggests, counter to previous studies, that too lax a monetary policy decreases the success probability of a fiscal adjustment episode.

Keywords:

• fiscal consolidations
• monetary policy
• nonparametric methods
• generalized additive models

JEL Classification:

• C14
• E62
• E63
• H63

Acknowledgement

We thank O. Reich for helpful comments.