Cross-Country Spillovers from Fiscal Consolidations

In the aftermath of the global financial crisis, many OECD countries adopted fiscal consolidation strategies to reduce their debt-to-GDP ratios. This paper investigates the effects of fiscal consolidation on trading partners' growth through trade linkages. Using a measure of exogenous fiscal shocks in export markets, fiscal consolidation spillovers are found to slow down domestic growth and decrease employment. To the extent that fiscal consolidations are synchronised, 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 lower bilateral exports, higher bilateral imports and relative increases in unit labour costs in currency unions. Spillovers of fiscal consolidation are also found to be more detrimental to domestic growth during economic downturns in export markets.