The Design and Implementation of Large Fiscal Adjustment Plans in the European Union 1

We study the design and implementation of large fiscal adjustment plans using a novel approach. Previous studies have focused on successful fiscal adjustments identified on the basis of outcomes. Instead, we analyze large fiscal adjustment plans and compares them with outcomes, thereby capturing lessons not only from successes but also failures, and avoiding sample selection/survivorship bias. In this paper, we analyze all large fiscal adjustment plans put forward by European Union countries in 1991–2008. On design, we find that large planned adjustments envisaged a greater role for expenditure cuts. Only a third of the plans provided for revenue increases, but most of these were not anchored in tangible tax policy measures. Plans were generally based on assumptions of improving macroeconomic conditions, but growth projections were not systematically optimistic relative to independent forecasts available at the time. On implementation, we find that three-fourths of the planned adjustment was realized on average, with sizable expenditure over-runs partly offset by revenue over-performance. Economic growth surprises are found to be key: one percentage point higher-than-planned growth improves the overall balance by 1⁄2 percentage point of GDP. There is some evidence that policymakers use growth and other surprises (such as revisions to initial-year deficits) opportunistically: partially “spending” favorable surprises, but permitting unfavorable ones to result in deviations from targets. 1 Abbas, Hasanov, and Mauro are in the International Monetary Fund’s Fiscal Affairs Department. Park is now a Ph.D. student at UCLA. We are grateful to Roel Beetsma for valuable comments and suggestions, to Katia Chen, Alica Dzelilovic, and Patricia Quiros for collecting the plans from various archival sources. The opinions expressed are those of the authors and should not be attributed to the International Monetary Fund. This paper is part of a broader effort on Chipping Away at Public Debt—Sources of Failure and Keys to Success in Fiscal Adjustment (Wiley, 2011), also summarized in the publicly available video by the same title.