The Trade-Off between Growth & Equality and the Economic Impact of Alternative Fiscal Adjustment Strategies in the EU

Abstract

This paper examines the economic impact of alternative budgetary compositions with an special focus on the effect that different fiscal adjustment strategies have on growth and equality. Based on a sample of 53 adjustment episodes occurred in the fifteen EU Member States between 1960-2000, this paper shows that different strategies of fiscal adjustment bring about different economic consequences. Expenditure-based adjustments that are preceded by bad economic and fiscal initial conditions, that are accompanied by a devaluation, and that succeed in cutting the least productive expenditures of the budget, are likely to have anti-Keynesian effects and to be expansionary. Nevertheless, they do so at the expense of increasing income inequality. The opposite is true for revenue-based consolidations. The nineties epitomize the story of expansionary fiscal consolidations via strong wealth and credibility effects, but also the rebirth of the trade-off between growth and equality, mediated by fiscal policy.