The results are in: Spending cuts, not tax hikes, are the road to recovery
Vuk Vukovic draws on new academic research to argue that the historical evidence around recessions is clear: cutting government spending, not Keynesian stimulus, is the way to create a recovery.
A new research paper by Alesina, Favero and Giavazzi focuses on measuring the output effect of fiscal consolidations. The idea is that fiscal consolidations tend to have much more favourable effects on the economy if they are done via spending cuts alone, not via increased taxation (see the graph below), which is actually what austerity is supposed to be.
Here's the abstract:
"This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions.” (Alesina, Favero, Giavazzi (2012) "The output effect of fiscal consolidations" Figure 3, pg. 40.)
