Fiscal Consolidation in Parliamentary Democracies: Influence of
Political and Budgetary Institutions under Economic Control

Makoto NAKANISHI

Working Paper Series Vol. FY2018-03
July 2018

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Center for Regional Economic Studies, Faculty of Economics

Saga University
1 Honjo-machi, Saga, 840-8502 JAPANFiscal Consolidation in Parliamentary Democracies: Influence of Politicaland Budgetary Institutions under Economic Control¶

Makoto NAKANISHI*
Faculty of Economics, Saga University

Abstract
One would expect a parliamentary democracy to make responsible choices when it comes to importanteconomic issues. Fiscal consolidation is one of such issues. In fact, the quality of a parliamentary democracy
can be measured by the elements of the political economy (such as political and budgetary institutions) that
influence implementation and success of fiscal adjustment. However, earlier studies in this area, whichappeared before the World Financial Crisis, have received a lot of criticism, in particular due to being too
optimistic in terms of their vision and premises. The current paper shows the importance of political andbudgetary institutions in implementation and success of fiscal consolidation, rigorously controlling forvarious economic and financial conditions and accommodative policies that have been largely overlooked in
the previous studies.

Key Words: Fiscal consolidation; CAPB; Political economy; Political Institutions; Budgetary Institutions.

¶ This study was supported by Center for Regional Economic Studies, Faculty of Economics, Saga University. The author is

grateful to valuable comments from Professor Haruo Kondo (Department of Economics, Seinan Gakuin University).
* corresponding to: kotmurka@cc.saga-u.ac.jp

1

Fiscal Consolidation in Parliamentary Democracies:
Influence of Political and Budgetary Institutions under
Economic Control
Makoto Nakanishi
Department of Economics, Saga university, Japankotmurka@cc.saga-u.ac.jp
July 4, 2018

Introduction
The reader may be aware that already for some time, even before the World Financial
Crisis of 2007-2008, four Southern European countries (SE-4; Italy, Greece, Spain, Portugal) and Ireland have been under a particularly zealous scrutiny for their fiscal fragility(Blavoukos & Pagoulatos(2008)). The Crisis has further destabilized public finance of
these countries, and reaction of the market to the sovereign debt crisis of these countries triggered the crisis of Euro currency. At the same time, it should be noted thatthese four European countries (SE-4) have a history of transition from authoritarianrule (O’Donnell et al.(1986)). Although this history is not recent, some deficiencies or
institutional immaturity might have remained since those times, and this implies a risk
for responsible fiscal governance required for democratic countries.
This list of such fiscally fragile countries might further be expanded by adding Japan,
because it also has a history of authoritarian rule spanning until the end of World War
II (along with Italy and Germany), and at present has over 240 % of debt to GDP
ratio, which is the worst among industrialized nations. We could also mention newly
integrated European countries that had been under Communist regime, another type of
authoritarian rule. These countries are clearly characterized by a certain institutional
immaturity, so they also are at a risk in terms of fiscal governance, although so far
this risk has not been considerable compared to the already mentioned countries withserious fiscal problems (SE-4 and Japan). As for other industrialized nations, their
way towards robust fiscal governance had also often been rather long. For example,
the Fourth Republic in France was famous for frequent government changes and fiscal
extravagance, so the Fifth Republic had to deal with this problem by giving more power
to the government rather than to the parliament and by improving budget institutions.
Thus, we have to conclude that responsible governance of a democratic country is a hard
won attribute, and not something easily obtained by one-shot ”democratization”.

Fiscal consolidation is a responsible act of a democratic country. It is needed toreestablish fiscal discipline in case the latter worsened, thus showing that popular will iscredible and capable of ”determining their own fate”. Of course, a democratic country
capable of responsibly deciding its own fate is ideally supposed not to need any fiscal consolidation. Rather it should be a second-best solution for such a country, because sucha country is supposed to maintain fiscal discipline either by keeping tight fiscal management or avoiding any fiscal adjustments. An eloquent example of this ”Noblesse Oblige”
concept is the fact that newly integrated EU member countries have been required toshow their ability to implement necessary fiscal adjustment to meet the Maastricht eligibility criteria. In reality, the aptitude for fiscal adjustment is dependent not only on
the economic structure and sensitivity to a financial boom, but also on constitutional
structure which could limit populist demand and facilitate the necessary radical andpossibly painful decision making.
This paper discusses the influence of political economy factors (political and budgetary institutions) on implementation and success (sustainability) of fiscal consolidation. Industrialized democratic countries have diﬀerent configurations of governancestructure, which could facilitate or hinder fiscal consolidation. Even though a country
could consider a project of fiscal consolidation, it might be unable to proceed with it
because of opposition on the part of the stakeholders, and such opposition might befacilitated by the constitutional structure, which might be excessively dependent on
separation of power. A fiscal consolidation project might not be sustainable because
the country’s institutional structure would lead to dissipation of the scarce resources
according to various demands of the stakeholders, if there are no preventive measuresthat could protect the country from the pork barrel politics. If we knew any political
economy factors that would lead to realization and success of fiscal consolidation, we
could conceive of some preliminary institutional reforms facilitating fiscal adjustment or
at least ponder the institutional risk when we consider a consolidation project.
Although a responsible democratic government should voluntarily reestablish its public finance once it worsens and exceeds a certain limit, it should not necessarily have toforce the reform when economic environment is seriously damaged, as is currently thecase after the World Financial Crisis of 2008. After the Crisis, many have started to cast
doubts on the legitimacy of proceeding with fiscal consolidation according to recommendations based on studies undertaken before the Crisis, because the Crisis highlighted a
possibility that some of the conclusions of these studies might have been wrong. For example, some episodes may have been wrongly defined as successes of fiscal consolidation
because they might have been the results of unusual financial boom that is a part ofthe cyclical adjustment of fiscal balance, but has not been properly recognized as such.
Other apparently successful fiscal consolidation episodes might be merely the results ofaccommodative monetary policy, and not a contribution of a fiscal adjustment project
itself. Our study of fiscal consolidation is based on the notion that such misconceptions
should not be treated lightly or considered irrelevant taking into account the seriousnessof the task of fiscal consolidation in these hard times.
In this paper, after rigorously controlling for economic environment and accommoda-

2

tive policies, we are going to show that we can still confirm in the influence of political
economy factors on decision making and success of fiscal consolidation. Although dueto the harshness of the recent economic climate, fiscal consolidation is diﬃcult to implement in many democratic countries, some of them have particularly suﬀered frompersistent demand and opposition of a populist kind, which must be overcome by finetuning institutional settings through adequate balance of competition and concentrationof power.
Political economy factors discussed in this paper are expected to have a certain
predictive power when the country in question follows a fiscal adjustment project andin this paper we measure the outcome of such a project. In this way, we will also beable to determine the normative power of political economy factors to guide the reform
agenda when a country has to overcome some particular institutional barriers that kept
hindering implementation or success of fiscal consolidation in that country in the past.
To tackle the above mentioned task, we chose the strategy of limiting the sample
of countries to parliamentary democracies. Parliamentary democracies are fundamentally diﬀerent from presidential democracies in the way the political economy factors
influence the institutional apparatus. Our sample is suﬃciently large for a general parliamentary democracy study. It is composed of 29 parliamentary democracies, includingWest European countries, East European countries, Westminster countries outside Europe (Australia, Canada, New Zealand), and Japan. Thus, our study could provide a
relevant degree of generalization, which is often lacking in the studies that focus only
on (West) European countries, or inversely on OECD countries so that presidential andparliamentary democracies are improperly mixed despite their fundamental diﬀerencesfrom the point of view of political economy.
Our objectives, represented by the corresponding sections of this paper, are as follows. First, reviewing the previous studies, we intend to configure various foundationsof our study. These comprise, (1) improved cyclical adjustment integrating asset value
movements and avoiding business cycle influence, (2) problems of controlling for initialconditions of consolidation and related research strategy that is particularly important
for the success of a fiscal consolidation, (3) relationship between political economy factors and fiscal consolidation concept, which is characterized by a radical change of publicfinance, and (4) related time dimension of research. Second, we suggest a definition of a
fiscal consolidation and its success and describe the data variables and empirical strategies adopted in this study. We then discuss the results of our study with respect toimplementation of fiscal consolidation and success of fiscal adjustment. The final section
mentions conclusions reached in this paper.

1

Configuration of Research Foundations

After the World Financial Crisis, when economic situation in many countries is rather
bad, research in the field of political economy of fiscal consolidation is diﬃcult, because
one has to adjust the methods of political economy research to the specific conceptof fiscal consolidation and integrate many studies that have highlighted and analyzed
3the problems of research undertaken before the World Financial Crisis. Reviewing theprevious studies permits us to establish the foundation blocks of our research.

1.1

Revised Method of Cyclical Adjustment

As the social background after the World Financial Crisis was changing, the tone of
the studies on fiscal consolidation has also changed. Before the crisis, the majority ofstudies had focused on the necessity and positive eﬀects of fiscal adjustment. The mostrepresentative authors of the studies along this line are Alberto Alesina, Silvia Ardagna& Roberto Perotti (so called AAP)(Alesina & Perotti (1995), Alesina & Ardagna (2010),
Alesina & Ardagna (2012)). They maintained that one of the major factors that contributed to the success of fiscal consolidation was the expenditure cut rather than tax
hike, and that this success also accompanies the expansionary eﬀect (Expansionary Austerity hypothesis or ”non-Keynesian Eﬀect”). However, IMF (2010) rejected their argument, criticizing their insuﬃcient control for economic performance (business cycle).
IMF (2010) warns against inconsiderate implementation of fiscal adjustment in a diﬃcult
economic situation.
Fiscal consolidation was often defined by using CAPB (Cyclically Adjusted Primary
Balance), which takes care of excluding business cycle elements in the definition of
fiscal adjustment. The data of CAPB has been published by the organizations such as
IMF, OECD, and EU. However, published CAPB data is not available for all countries
for all necessary years. Thus, researchers often had to make their own data sets of
CAPB to use in consolidation studies. Among others, Blanchard Fiscal Impulse (BFI)(Blanchard(1993)) is the most convenient method to calculate CAPB and is used bymany researchers. This method allows to easily neutralize the influence of business cycles
using unemployment rate. An indicator of discretionary fiscal policy in this method is
calculated by subtraction of the preceding year’s BFI (per GDP) from current year’s
BFI, which is supposed to be realized if the level of the unemployment rate is the samefor both years. This approach is used in the studies of AAP and other studies belonging
to the same current of thought.
The first point of IMF’s criticism regarding AAP’s approach is the measurement error, which occurs because AAP do not consider the movements of asset value, resulting
in a wrong recognition of discretionary fiscal consolidation or expansion without neutralizing such movements. The second point of IMF’s criticism is that AAP’s approach
fails to capture the true motivation of governments behind the superficial movementsof economic / fiscal figures. A country might intentionally plan and implement a fiscal
adjustment project, but a negative economic shock encountered right after the fiscal
adjustment would not allow to observe the economic and fiscal record of consolidation.
To highlight the motivation hidden behind the record, IMF (2010) reexamined the governmental documents to figure out the governments’ intentional consolidation eﬀorts to
be defined as fiscal consolidation episodes (Pescatori et al.(2011)). Using this approach,
IMF (2010) reports that fiscal consolidation lowers economic growth.
Nonetheless, IMF’s descriptive approach has its own weaknesses. One of them is themeasurement error. As Perotti (2011) pointed out, a government can initially plan fiscal
4

consolidation, in the budgetary or planning documents, but give it up in mid-year andreverse the already-decided policy using supplementary budgets. It is also diﬃcult todetermine the true intention of policy change by reading only governmental documents.
For example, even if a consolidation is correctly considered to be motivated by a desire
to reduce debt, it is not clear that it would have actually been undertaken if the economy
went into a recession (Holden & Midthjell (2013)). Ultimately, such a policy document issimilar to an electoral program, a famous example being Georges H.W.Bush’s manifesto”Read my lips: No new taxes.” It is dangerous to believe in manifestos on their facevalue.
The idea behind our political economy study is to observe behaviors of governments
without blindly believing in the ”face value” of governmental statements. In our definition of fiscal consolidation we follow an approach based on data rather than governmental
statements. In any case, we cannot use IMF’s database because it is based on ”ActionBased Approach,” which limits their sample of countries, because in this paper we study
29 parliamentary democracies, including Central and East European countries. BFI isstill useful for its simplicity to make data, but in order to be able to use it one needs toresolve its inherent problems already discussed above.
In this paper we integrate the recent improvement of CAPB calculation using theconcept of BFI. First of all, we integrate asset value movements, which is one of themeasurement errors found in traditional BFI and which is integrated into CAPB calculation in the study of Yang et al.(2015). Second, we integrate the criticism of Holden& Midthjell (2013) on ”Reverse Causality” found in the AAP approach. To solve thisproblem, the latter recalculate BFI using fiscal figures without dividing them by GDP.
AAP’s BFI is calculated based on fiscal figures divided by GDP. In this case, thechange of denominator (GDP) can change fiscal balance per GDP even if the numerator(fiscal figures) remain unchanged. Thus, this approach cannot correctly neutralize theinfluence of business cycles. The ”Reverse Causality”1 that they mention implies thefollowing. A successful fiscal consolidation episode might not be due to the expenditurecut. It can result from (consistently) high economic growth, which lowers government
expenditure per GDP (mainly by increasing GDP-denominator of the ratio), and simultaneously assures lower debt to GDP ratio after a couple of years of fiscal consolidation.
This problem is important in considering the success or more generally the eﬀects (including expansionary eﬀect) of fiscal consolidation. But even for the implementationof fiscal consolidation, we can add another reason to avoid this approach as figures per
GDP bring us wrong regression results2 .
1

Before Holden & Midthjell(2013), Heylen & Everaert(2000) had already remarked the same problem.
The latter defined fiscal consolidation using CAPB per ”potential” GDP. However, they showed neither
their method of estimating the CAPB measure, nor the link between their remark and estimation method.
2
For example, two cases of GDP decrease without expenditure change, and expenditure increase
without GDP change may lead to the same result, although the output gap may turn negative in theformer, while it may not change in the latter. Usually negative output gap accompanies worsened
unemployment rate, implying changes related to business cycles. If government expenditure tends toincrease when unemployment rate worsens, automatic expenditure increase is to be expected in theformer case. However, since expenditure does not actually change, discretionary expenditure above the5Thus we modify the method of CAPB calculation or BFI, integrating the recommendations of Yang, Fidrmuc & Sugata(2015) as well as Holden & Midthjell(2013). The
revised CAPB calculation is as follows. We run the following regressions on diﬀerences,because these variables are non-stationary when they are not measured as ratios to GDP.
∆Tt = α0 + α1 T rendt + α2 ∆Ut + α3 ∆At + ϵt(1)∆Et = β0 + β1 T rendt + β2 ∆Ut + β3 ∆At + ϵt(2)where Tt and Et are revenue and primary expenditure, T rendt is a time trend, ∆Ut
is the change in the rate of unemployment and ∆At is the change in asset prices. All
aggregates (T, E, A) are deflated by GDP deflator here. The cyclically adjusted variables
for the year of adjustment are then given by:
Ttca = Tt − αˆ2 ∆Ut − αˆ3 ∆At
E ca = Et − βˆ2 ∆Ut − βˆ3 ∆At(3)tThus, the cyclically adjusted ratios to GDP are obtained by dividing the sum of
the cyclically adjusted government revenue Ttca and the cyclically adjusted government
primary expenditure Etca by the measure of predetermined real GDP, Yt∗ for the year of
the fiscal adjustment episode. The predetermined trend of real GDP, Yt∗ , is calculated
in this paper using Hodrick Prescott Filter3 .

1.2

Control for Initial Conditions of Successful Fiscal Consolidation:
From Comparative Study to Regression Method

The ”Expansionary Austerity” thesis of AAP and other related studies on successful
fiscal consolidation was based on a very simple approach of a comparative table. In
connection with comparative tables Holden & Midthjell (2013) point out the problem
of controlling for initial conditions of fiscal consolidation. Although AAP used theircomparative table to argue that successful consolidation episodes are supported throughbuilt-in-stabilizer part would turn negative. On the contrary, in the latter case, there is no change of
output gap and no business cycle related changes, and all increases of expenditure are of discretionary
nature. Thus we can expect negative discretionary expenditure in the former case and positive one in
the latter, although both lead to the same result if we calculate using figures per GDP.
The same figures of diﬀerent nature are mixed in the data used in regression analysis for each country isimplemented to calculate BFI to obtain discretionary government actions. Such regression identifies between two completely diﬀerent economic states from business cycle point of view, leading to an inevitableconfusion between ”built-in-stabilizer” part and the part of discretionary governmental actions.
There is another indication that AAP’s BFI, which uses figures per GDP, is not useful for neutralizing
the eﬀects of business cycle related changes in economic performance. In fact, AAP themselves haveoften remarked that the results remain basically the same even when CAPB is replaced by non-cyclicallyadjusted fiscal balance.
3
Holden & Midthjell(2013) define this as ten-year lagged moving average of real GDP.

6

expenditure cut, rather than tax hike, these episodes are also characterized by high initial growth rate and low initial outstanding debt. High growth rate tends to continue
over rather long periods of time and can influence the probability of successful fiscal
consolidation. So, in fact, such a comparative table compares apples and oranges and it
would seem inappropriate to use it to draw a conclusion that, for example, expenditure
cut is more advantageous for achieving expansionary austerity or successful fiscal consolidation than tax cut. This is the essence of Holden & Midthjell (2013)’s criticism of
AAP’s comparative table. They suggest an improved BFI calculation, which does not
involve dividing the figures by GDP and which can be expected to mitigate this problem.
However, even with improved business cycle adjustment, high structural growth may
result in high future growth and therefore be advantageous for attaining sustainabilityof a fiscal consolidation. Thus, although Holden & Midthjell(2013)’s approach could
partly mitigate this problem, this solution is only partial and researchers often use
multivariate regression, which allows to obtain ”marginal eﬀects of single variables byholding all other variables constant” (often at their mean values). Thus, if we want todistinguish the relative advantage of a consolidation strategy (expenditure cut/tax hike)from structural growth or initial outstanding debt, we have no choice but to rely on
multivariate regression, because in this case a comparative table would oﬀer no help.
The problems inherent in comparative tables used in the studies of AAP are notlimited to controlling for ”initial” conditions of consolidation. In fact, the studies on
successful or expansionary fiscal consolidation have one important specific feature thatis not usually found in the studies on consolidation decision making. The problem isthat the outcome in the former type of studies is measured not at the time of decision
making, but only ”afterwards,” that is, two or three years after consolidation decision
making. This means that social and economic changes that occur after the consolidation
episode might influence the outcome of consolidation, governmental debt sustainability(”successful” consolidation) or high growth (”expansionary” consolidation) in the future.
This point has never been recognized in the previous studies as far as we know, andwe can say that all the previous studies have failed to neutralize the influence of any
environmental changes occurring after the implementation of consolidation.
Previous studies often use lag variables, conscious of the endogeneity problem, inorder to avoid accumulating the impacts of consolidation seen in control variables. This
treatment is understandable, but if only initial conditions are used as regressors andthe eﬀects of consolidation are measured two or three years later, slight changes ininitial conditions would result in very poor explanatory power regarding the eﬀects ofconsolidation. Therefore, it is necessary to include some elements that would take careof environmental change after the consolidation episode, although this would certainlypose a persistent endogeneity problem that would need to be solved.
As Perotti (2011)’s self-critical case study illustrates, some of the success stories offiscal consolidation episodes could be explained by accommodative monetary or exchange
policy. However, consolidation might lower the interest rate by lowering the risk premium in the government bond market or other related markets (Perotti (2011)). Thus,
controlling for a change in the interest rate that occurred after the consolidation would

7

necessarily cause an endogeneity problem, and this is what troubles us in this researchstrategy. However, if we omit events occurring after consolidation from the analysis,
we would end reporting that success of fiscal consolidation was due to accommodative
monetary policy or interest rate fall, although these events might not be related toconsolidation as such.
In order to provide some sort of a solution to this problem, we decided to adopt thefollowing strategy. In place of using the change of interest rate as one of the regressors,
we introduce a dummy variable, which returns unity if the nominal short interest rate isless than required by the Taylor Rule, and zero otherwise. We use this zero-one variable
since we suppose that a possible consolidation related fall of the interest rate is going to
be relatively limited in size and its influence on the value of this dummy variable is going
to be weak. Thus, although we cannot completely exclude the endogeneity problem bytaking an interest rate related variable measured after the consolidation, we expect tolargely mitigate this problem.
There is another aspect that should be treated with caution, and it is related tothe state of the business cycle after the fiscal consolidation. Even though expenditurecut might appear more advantageous than tax cut in achieving sustainability of fiscal
consolidation, this might be due to good business conditions in case of expenditure cut
dependent fiscal consolidation. We must control for this business cycle problem, but
it is a very delicate task because ”Expansionary Austerity” thesis suggests that fiscal
consolidation ”is” the cause of good business conditions, often measured by yearly growthrate. Thus, it might be diﬃcult to decide whether we should include any indicators
related to business cycle, measured after the consolidation, into our analysis, because
omitting them would mean omitting control for the case of a ”fortunate” situation during
a business cycle leading to successful consolidation, while including them would leave us
with endogeneity problem.
In this paper, we deal with this diﬃculty by adopting the same approach that we usedwith the interest rate. We introduce a zero-one dummy variable corresponding to positiveor negative output gap after the consolidation. Although we admit that ”Expansionary
Austerity” thesis or inversely the ”Keynesian Eﬀect” (stating that consolidation chills
out economy) claimed by IMF (2010) would hold, we supposed that the influence ofconsolidation episode on the growth rate is not total and is limited in size relative toother confounding factors, which could increase or lower growth rate measured two or
three years later, thus not influencing greatly the zero-one indicator of business cycle.
We know that this approach alleviates the endogeneity problem but does not get rid of
it. Of course, we admit that, even though consolidation and interest rate are related
only to a limited degree, the relation between consolidation episode and output might besomewhat stronger. As a precaution, we integrate a sensitivity analysis by consideringa case with such output gap dummy variable and a case without it. The two cases arethen compared and we expect to have relatively stable results for both cases4 .
4Together with Holden & Mitdjhell (2013) and AAP, we could undertake a similar regression approach
not only for successful consolidation, but also for expansionary consolidation. However, our calculations
have shown that estimation results are unstable between the model with the output gap variable and8Another related problem is that the approach of AAP cannot distinguish a fiscal
consolidation episode from other fiscal movements. AAP’s comparative table typicallycompares the values of various indicators measured two years before and two years after
fiscal consolidation. It also compares successful (or expansionary) consolidation casesand other cases. Integrating the figures of two years before consolidation is totallyirrelevant because they are not related to consolidation episodes (such figures must be
measured at the time of consolidation, or with one year lag if we hope to measurechange occurring during a consolidation episode). Besides, if we measure the values ofindicators two years after consolidation with ”initial conditions” of fiscal consolidation,
we will end up including fiscal movements that are not directly linked to the relevant
fiscal consolidation episodes. Even though the values of indicators taken one year before
consolidation and two years after it might diﬀer greatly, we won’t know whether thisis due to a contribution of the fiscal consolidation episode itself or to some other fiscal
movements that occurred at the same time.
Therefore, we believe that in order to make a relevant assessment of fiscal policies
it is necessary to integrate in the analysis any fiscal movements that might have occurred after consolidation episodes. In fact, AAP’s conclusion that expenditure cut is amore advantageous strategy for achieving successful or expansionary consolidation thantax cut might prove wrong if the data are analyzed using a multivariate regression approach with integration of some regressors measuring fiscal movements that occurred
after consolidation episodes. This latter approach allows to measure ”marginal eﬀects”
of expenditure cut strategy or of tax cut strategy, taking other variables as given andincluding additional variables measuring fiscal movements after the consolidation, while
conclusions of AAP’s comparative approach are drawn without consideration of any suchlate-stage fiscal movements.

1.3

Political Economy Adapted to the Specificity of Consolidation
Concept

After resolving a number of intricate problems inherent in recent fiscal consolidation
studies, we must turn to political economy dimension of the question, which is the main
focus of this paper.
Relationship between political institutions and fiscal discipline has traditionally interested political economists. The studies in this field have been relatively abundant,
including the studies, which explore how coalition government is related to the fiscal
discipline (Volkerink & de Haan (2001), Mierau, Jong-A-Pin & de Haan(2007), Elgie &McMenamin (2008), de Haan, Jong-A-Pin & Mierau(2013), Wehner(2009, 2010). Studies, which analyze fiscal consolidation from the perspective of political economy, arefewer, but these are the studies that interest us the most. Among them are the following studies that discuss the link between political institutions and fiscal consolidation,
the model without. We find that expansionary consolidation cannot be analyzed with the help of either
comparative tables or multivariate regression approach (probit model...etc.). One would need to use
ARDL or VAR as was done in IMF (2010) and Alesina, Favero & Giavazzi (2015) studies.

9namely: Guichard et al. (2007) (elections), EC (2007) (elections and parliamentary
majority), Lassen (2010) (polarization, coalition, minority), Tagkalakis (2012) (Years inoﬃce, ideology, margin of majority, elections, governmental fractionalization), Molnar(2012) (election, ideology), Dell’Erba (2013) (elections, years left in current term, polarization). This type of studies have sometimes obtained interesting results, althoughoften the results were insignificant in terms of political influence on fiscal consolidation.
For example, Mierau, Jong-A-Pin & de Haan(2007) classify all consolidation episodes
into radical consolidation episodes and gradual consolidation episodes, maintaining thatthe decision making in case of radical fiscal consolidation is influenced only by the timing of election, while for gradual fiscal consolidation the decision making is influenced
by the number of governmental parties and the ideology of the government. MulasGranados(2006) shows that the size of the cabinet (number of spending ministers) andelections significantly influence the probability of starting a fiscal adjustment. However, even these studies have not had good results related to other variables of political
economy.
It is possible that our choice of variables does not reflect the fact that fiscal consolidation involves a radical change of the fiscal state, and this might be one of the causesthat sometimes prevented us from obtaining results that would clearly describe how political institutions influence the fiscal situation. On the contrary, the concept of a vetoplayer (Tsebelis (2002)), on which this paper focuses, reflects very well the rapid pace ofchange inherent in fiscal consolidation, as the separation of power is generally thought tohinder sudden social changes including fiscal consolidation. Therefore, this paper further
develops the study of fiscal consolidation along the lines of the work by Pamp (2008),
which uses the concept of veto players. The variable that we adopt for veto players is
a composite index integrating (semi-)presidential/parliamentary democracy, bicameralism, federalism, that is, decentralized power structures that might prevent radical socialchanges, including fiscal consolidation, from happening.
”Government Fragility” is another factor which might slow down or accelerate institutional changes. So far, coalition government has been thought to be a sign ofgovernmental fragility, which is likely to cause deterioration of public finance. However,in terms of institutional changes, on which this study focuses, we must specify a function of governmental fragility with respect to facilitating or slowing down social change
including fiscal adjustment. Typically, government parties create an electoral program,upon which these parties could agree. After gaining a majority in the government, theseparties would agree upon a new fiscal plan, often with mid-term time horizon. However,
due to the diﬀerence in ideology between parties, such fiscal plan is not likely to beobserved. Often, disputes concerning fiscal problems causes the coalition of government
parties to break up. In this case reelections or reshuﬄing of government parties would
be inevitable. Thus, government fragility is an important factor that has very much to
do with the sustainability of institutions. We adopt a variable of government fragility
from the ideological gap in coalition government.
As a matter of fact, we can also regard this variable of government fragility as ”partisan” veto player concept, while the aforementioned variable of composite institutional

10

index can be interpreted as ”institutional” veto player concept (Tsebelis (2002)). Thisvariable can also serve as a sign of resistance of the society against new changes and canbe considered to represent the power of governmental composition to resist reforms, andinitiation of reforms. However, when we focus on the continuation of reforms, we shouldinterpret this variable as a sign of instability rather than stability. This ambiguity ofthe variable should be kept in mind while reading our analysis.
Other political variables that we adopt for our study concerning implementation of
fiscal consolidation describe the ideology of governmental parties and the seat share ofgovernmental parties. We conjecture that conservative ideology (positive values of thecorresponding variable) is likely to be linked to fiscal consolidation, implementation ofwhich is also thought to be facilitated by the dominance of governmental parties inparliament. Seat share may also be a supplementary indicator of governmental fragility
as well as of the ideological gap between governmental parties (as already mentioned). In
order to reflect the situation with successful consolidation, we included a dummy variableof legislative elections. The variable is a one-year lag variable and is not supposed toillustrate facilitation of successful consolidation due to elections, but inversely to showthat the elections are already over and politicians have little concern on approaching
election facilitating tight fiscal management as they need less to buy the votes.
As for ”Budgetary Institutions”, the research of von Hagen and Hallerberg and related studies illustrate that budget institutions play an important role in keeping the
fiscal discipline (for example, Hallerberg et al.(2006)). However, our focus is on fiscal
consolidation, and not on fiscal performance in general. There have been some fiscal
consolidation studies, which discussed the relationship between budget institutions andfiscal consolidation, and they often included balanced budget rules or numerical fiscal
rules (EC (2007), Lassen (2010), Molnar (2012), Dell’Erba (2013)) to represent the socalled ”budget institutions”. On the contrary, budgetary ”procedures” have rarely been
examined, while the exceptional study by EC (2007) and Larch & Turini (2008) tested
the influence of budgetary procedure index on initiation and success of fiscal adjustment.
The results were significant, although they were obtained by regressions run sequentiallyby adding each individual additional variable to the baseline model, thus this method
has limitations similar to those of univariate regression, which we avoid in this paper toobtain ”marginal eﬀects”, supported by the ”ceteris paribus” hypothesis. Transparencyof budget institutions was examined by Lassen (2010).
This paper supposes that numerical rules do not have much influence on fiscal discipline or economic policy, as they have only a superficial role if they lack the relevantbudget procedure which put some executive eﬀectiveness for such rules (although one of
the indicators in our budget procedure index is related to numerical rules). Transparency
is also important, but is thought to be only one of the elements of centralization of thewhole budget procedure. The reason why we focus on the budget procedure, rather thanon numerical rules, is that the budget procedure is related to the centralization of powerin budgetary process. Since we are interested in fiscal consolidation, radical change offiscal management, centralization/decentralization of power accelerates/decelerates such
radical change. Besides, we intend to analyze 29 parliamentary democracies including

11

East and Central European countries, although the database for such a large sample
is only available in relation to the budget procedure (we refer mostly to the databaseof Fabrizio & Mody (2010), which is constructed partially based on Ylöutinen (2004),
on the data about East and Central European countries)5 . Starting from the databaseof Fabrizio & Mody(2010), we integrated the data of Australia, Canada, New Zealandand Japan using our own documentary research and fieldwork (as for Japan we also referred to von Hagen(2008)). The data used in this paper on budget institutions is shownin Appendix A7 (refer to our working paper to know the whole database and related
background research (Nakanishi(2017))).
Budget institutions have been justified as a mechanism of containing deficit and debt
as they work to avoid Common Pool Resources”(CPR) problem (von Hagen & Haden(1996)). However, ”Budget Institutions” are a set of various small procedural rules thatwork subtly and progressively. Gathering small saving functions, ”Budget Institutions”
are supposed to take time to reach the state of the fiscal discipline. Therefore, theywork particularly well when continuous eﬀorts are needed. Their working mechanism ofaction is contrary to that of veto players which hinders radical decision making. Thisdiﬀerence of function between the variables of budget institutions and veto players is
to be taken into account, when we consider political economy factors of starting andcontinuing fiscal consolidation, as well as those of a successful consolidation which needs
continuous eﬀorts of fiscal improvement measured after consolidation episode.

1.4

Time Dimension of Fiscal Consolidation: Markov Transition Model
for Consolidation Implementation

This paper adopts the concept of a multi-year fiscal consolidation episode, which includes
both the starting year of a consolidation episode and the years that follow, and these two
can be considered to be of a completely diﬀerent nature. During the starting year thegovernment tries to radically change the previously adopted fiscal management, while inthe years that follow its eﬀorts are concentrated on preserving the newly adopted fiscal
management, rather than changing it, which means that the intention of the government is opposite to what it was during the starting year. Political economy elements,
including the concept of the veto player, are also sensitive to this dichotomy along thetime dimension, so some of these elements would exert their influence in the beginning,aﬀecting the stage of starting the consolidation, while other mechanisms would aﬀect
the progress of the fiscal consolidation during subsequent years.
As a matter of fact, this strategy of dividing the episode of fiscal consolidation into
starting years and subsequent years can help to avoid serial correlation problems that
could arise in case of Time Series Cross Section data structure (i.e. long panel data).
Usually, when one needs to consider Time Series Cross Section data structure for a binarymodel, a special approach is needed, and it is often conceptualized under the name of5

Famous database of von Hagen and Hallerberg is that of 15 EU countries excluding East European
countries. Larch & Turini (2008) rely on OECD/World Bank Budget Practices and Procedures Database(2003), while this database has many missing values and is based on self report of governmental oﬃcers
which is not necessarily credible.

12

BTSCS (Binary Time Series Cross Section) analysis (Beck, Katz & Tucker(1998)). In
fact, there have been political economy studies of fiscal consolidation, which took thisperspective into account. For example, Mierau et al.(2007) & Wagshal & Wenzelburger(2011) meticulously analyzed the problem of serial correlation in discrete choice modeland adopted the BTSCS (Binary Time Series Cross Section) method mentioned in Beck,
Katz & Tucker (1998). However, this method has one weakness. Although it integrates
the concept of duration into discrete choice model using splines or other techniques, theanalysis would be limited to the starting year, while the subsequent years will have tobe dropped (Beck, Katz & Tucker (1998)), so the method cannot be used to analyze theyears beyond the starting year of a fiscal consolidation episode.
Another way of dealing with the BTSCS problem has been proposed by Beck (,N.D.)
et al.(2001). It is referred to as ”Markov Transition Model” and allows to analyze any
event, including fiscal consolidation event, by dividing it into two cases, one with theprevious year assigned a value of ”1” (the event occurred) and the second one with theprevious year being assigned a value of 0 (the event did not occur).
This paper adopts this method not only because it is a good solution to the serial
correlation problem in a discrete choice model with time series cross section data structure, but also because it is also interesting from the point of view of determining fiscal
policy, because it distinguishes between the two cases as regards the starting year andthe subsequent years of a consolidation event. This is a distinction especially useful indetermining how the political economy factors influence the specificity of fiscal consolidation decision making. Thus, this BTSCS analysis should be applied to the studyof implementation in fiscal adjustment of multi-year concept where distinguishing thestarting year and the ongoing years of one event makes sense6 .

2

Data, Variables and Fiscal Consolidation ConceptThis is a political economy study of fiscal consolidation in phases of its implementationand its success (sustainability). For this objective, we must define the notions of a
fiscal consolidation episode and of a successful fiscal consolidation episode. We mustthen introduce diﬀerent variables for the decision making of consolidation and for thesustainability of consolidation. We will also describe the data sources and estimation
techniques.

2.1

Redefining Fiscal Consolidation Concept

Apart from tasks related to CAPB calculation, there seems to be no unique and clear
definition of fiscal consolidation based on one of CAPB measures or some other measureof fiscal balance. Any such definition is, after all, arbitrary. In this paper, we adopt
the definition used by OECD-related researchers, such as Guichard et al. (2007). The
6
We need to use the usual probit analysis in case of successful fiscal consolidation because in thiscase the study loses the character of time series cross section data structure. The data does not cover
all years and we have only several samples of isolated consolidation episodes.

13motivation behind this choice is that this paper uses the data on parliamentary democracies, so that our sample includes the majority of OECD member countries, excluding,however, industrial countries with presidential democracy. This definition also has anadvantage of integrating the multi-year aspect of fiscal consolidation7 . Thus, the following is the definition that this paper adopts for fiscal consolidation:✓
Definition of Fiscal Consolidation

A fiscal consolidation episode:✏• Starts if the CAPB improves by at least one percentage point of potential
GDP in one year or in two consecutive years with at least 1/2 percentage
point improvement occurring in the first of the two years.
• Continues as long as the CAPB improves. An interruption without terminating
the episode is allowed as long at the deterioration of the CAPB does not exceed
0.3 per cent of GDP and is more than oﬀset in the following year (by an
improvement of at least 0.5 per cent of GDP).
✒• Terminates if the CAPB stops increasing or if the CAPB improves by less than
0.2 per cent of GDP in one year and then deteriorates.

After giving a definition of fiscal consolidation as such, we must define ”successful”
fiscal consolidation, which Holden & Midthjell (2013) integrated in their study to compare the sustainability of fiscal consolidation resulting from diﬀerent strategies of fiscal
consolidation (expenditure cut or tax hike, size of consolidation, etc...). As for successful consolidation, i.e. sustainability or at least stabilization of debt decrease, Alesina& Perotti (1995) adopted a definition, according to which a consolidation episode isconsidered successful when the debt to GDP ratio 3 years after consolidation decreases
by more than 5 %(per GDP) compared to the preceding year. We find this criterion
too strict, especially under conditions of the current post-crisis economy, and even unrealistic from the point of view of a country with a huge debt, such as Japan, with nopossibility of balancing primary balance in the following three or four years. Besides,
economic theory requires us to stabilize the evolution of debt to GDP ratio, and not todiminish this ratio. These considerations made us relax the criterion of successful fiscal
7

This paper adopts a multi-year concept of fiscal consolidation, employing yearly counting of eachfiscal consolidation episode in a spell of multi-year fiscal consolidation. Many previous studies also
adopt this approach, although there are other approaches that consider the entire spell of multi-year
fiscal consolidation episodes as a single episode. We prefer the former approach because we are keen
on controlling the initial state of fiscal consolidation. For example, if a spell of consolidation episodes
continues for 7 years, counting the whole spell of consolidation episodes as a single episode would result
in considering the economic environment of 8 years before the consolidation, which is too far from theeﬀects of fiscal consolidation, such as sustainability or expansionary eﬀect of consolidation measured two
years after the ”end” of such spell. On the other hand, if we consider annual partition of multi-year
consolidation episodes as unnatural, we would have to adopt Perotti (2011)’s case study approach, whichtries to consider one multi-annual episode as a band and discuss the initial condition of such episode”qualitatively.”14✑consolidation replacing it by a condition stating that the debt to GDP ratio, calculatedusing real GPD, does not grow.
✓Definition of Successful Fiscal Consolidation

✏

✒

✑

A fiscal consolidation is considered successful if the cumulative change of thedebt to GDP ratio between the year of adjustment and two years afterwards isnegative:(D/Y )t+2 − (D/Y )t−1 < 0.

Following these definitions of the implementation and the success of fiscal consolidation, all relevant episodes are counted as country/year, and their list is shown inAppendix A at the end of the paper.

2.2

Data and Variables

Based on all the above consideration, we integrated the following variables in our analysis, where the expected signs of these variables are shown at the upper right side of thevariable names. As for probit estimation of consolidation decision making, we adopt thelag variables to avoid endogeneity (except the contemporary dummy variable of financial
crisis). The descriptive statistics appear in Appendix A2.
✓
Variables for Fiscal Consolidation Decision Making

✏

✒

✑

Structural Growth Rate(Past 5 Years Average)+ , Output Gap+ , Debt
Outstanding +/− , Interest Rate− , Money Supply + , Eﬀective Exchange Rate− , Current Account(Past 5 Years Average)+ , Financial Crisis Dummy(Past 5 Y ears)− ,Financial Crisis Dummy(During the Y ear)− , Veto P layers− , Governmental
F ragility − , Governmental Ideology + , Seat Share+ , Budget P rocedure− , Past
Episodes of Fiscal Consolidation+

First, we integrate a set of initial control variables, some of which might be significant if improvement of CAPB calculation expected to neutralize initial conditionsof consolidation turns out to be insuﬃcient. Consistently high growth rate before theconsolidation might facilitate consolidation decision making. The same is true for an advantageous business cycle. If the sign of the variable of government debt is positive, thismeans that larger government debt would lead to a greater need of fiscal consolidation.
If this sign is negative, this means that smaller government debt would facilitate theimplementation of fiscal adjustment because in this case the task of fiscal consolidation
would be easier to be undertaken. For these 3 variables, we expect insignificant results,
even though we expect to obtain the right signs.
Accommodative monetary or exchange rate policies could facilitate consolidation
decision making. We measure both types of accommodative policies using alternative
variables, interest rate and money supply for the former and exchange rate and current
account for the latter. For the latter, for example, the fall of exchange rate might boost
export boom and facilitate consolidation. However, export boom might by triggered by15

other causes than exchange rate, or exchange rate might bring about a positive expectation on economy, which might facilitate consolidation without immediately leading toany export boom. Thus, we find that such alternative measures are useful and makesense in this implementation analysis. We also include financial crisis dummy variables,
because countries might wish to avoid consolidation during or right after the crisis, as ispointed out by the study of Barrios et al. (2010).
As we discussed in the subsection on political economy variables, in our research we
integrate the variables of institutional veto players, of governmental fragility (”partisan”
veto players), of governmental ideology, of governmental seat share in parliament, andof budget procedure. As for budget procedure, if it facilitates any fiscal improvement
it would have a positive sign, but if it makes it unnecessary for a country to resort
to fiscal consolidation, for example, because fiscal discipline is constantly assured, wewould expect to obtain a negative sign. We also include a variable for past episodesof consolidation, which are often included in BTSCS analysis to control for relativeadvantage of past experience on a new event.
As for analysis concerning the success or sustainability of fiscal consolidation, we
have already mentioned that we decided to include variables to control for initial conditions and accommodative policies, political elements and factors of post consolidation
economic and political environment. The following is the list of variables used in regression analysis on the successful outcome of fiscal consolidation.
✓
Variables for Successful Fiscal Consolidation

✏

✒

✑

Structural Growth Rate(Past 5 Years Average)+ , Debt Outstanding +/− , Veto
P layers− , Governmental F ragility − , Election Dummy + , Budget P rocedure+ , Financial Crisis Dummy(Past 5 Y ears)− (So far one year lag variables), Financial
Crisis Dummy(During the Y ear)− , Change of Expenditure at t− , Change of Revenue at t+ , Change of Expenditure at t + 1 and t + 2− , Change of Revenue at t + 1
and t+2+ , Interest Rate− Dummy(after consolidation), Output Gap+ Dummy(after
consolidation)

The first two variables of structural growth rate and outstanding debt are particularly
important to control for initial conditions of consolidation in order to evaluate whether
it is successful, measured two years after the consolidation episode. If these two variables
return some significant results, that would mean that the problem of controlling for the
initial conditions persists even after the research strategy has been radically changed(from comparative table to multivariate regression (probit)). Thus, we hope to obtainnon significant results for these two variables.
As for political variables, we continue to use the two variables of veto players andgovernmental fragility. The former is expected to hinder successful consolidation. If thesuccess of consolidation is somewhat similar to the decision to continue with the consolidation, the variable of governmental fragility is expected to be of some importance forfiscal sustainability. To check whether there might have been elections in the preceding
year, we include an elections dummy variable. In case there have indeed been elections,16we expect this variable to be positive, because if the elections are over, fiscal consolidation is easy to continue and consolidation might be successful. Budget institutions
would return a diﬀerent result from that obtained in the analysis related to consolidation
implementation (the sign might be negative), the relevant variable is expected to havea positive sign and a statistically significant result.
The assessment of the sign of variables is particularly diﬃcult for contemporary
revenue and expenditure change. One may expect expenditure change variable to be
negative and revenue change variable to be positive, but because AAP preferred expenditure cut to tax hike as a successful fiscal consolidation strategy, the latter would havea less positive or even negative marginal eﬀect. The point here is that, in contrast to
AAP’s comparative table approach, we integrate the regressors of fiscal management
after the consolidation episode. These are control variables that serve to obtain thecorrect sign and value of contemporary expenditure and revenue change variables, thus
we do not have any particular expectations as regards the signs and values of these variables. After controlling for post consolidation fiscal management, contemporary fiscal
movements might not return the results that have so far been often claimed by otherresearchers, including AAP.
We also introduce an interest rate dummy that shows whether the test is superior
or inferior to what is dictated by the Taylor Rule. This variable is needed in order toinclude the eﬀects of accommodative monetary policy. We also include the variables offinancial crisis in the same way as we included them in implementation analysis. Finally,
we control for business cycle movements after consolidation. With respect to uncertainty
in terms of Keynesian/non Keynesian output eﬀect of consolidation, we include a model
containing this variable and a model without in order to perform a sensitivity analysis.
We are going to analyze the implementation and the sustainability of fiscal consolidation through probit estimation using all above-mentioned preliminary considerations. The variables used are listed in Appendix A3, while the descriptive statistics
are shown in Appendix A4. Our data source is based on OECD Economic Outlook
Database No.92, IMF International Financial Statistics, Worldbank World Development
Indicators, Worldbank Political Institutions Database, Comparative Political Data Set
3, Manifesto Project Database.

3

Factors of the Implementation of Fiscal Consolidation

Based on considerations listed above, we analyze first the implementation of fiscal consolidation using probit estimation, distinguishing the starting years and the subsequent
years of fiscal consolidation.

3.1

Factors Influencing Initiation of Fiscal Consolidation

If we consider starting years of consolidation (left hand side of Appendix A.4), we cansee positive marginal eﬀects of output gap, growth rate, debt outstanding, although noneof them is statistically significant. One can see that control for business cycle influence17

is no longer needed after CAPB redefinition. Positive sign for outstanding debt can beinterpreted to mean that the worse the state of public finance, the more consolidation
would be needed, but without statistical significance.
On the contrary, in the case of accommodative policies, negative interest rate, positive money supply, negative exchange rate, all the related variables have statisticalsignificance. This means that accommodative monetary and exchange policies helped
the consolidation to be realized a year later. Although positive current account has only
10 % significance, it might suggest that export drive has helped consolidation implementation. The signs of financial crisis, past or present, are all negative, and this might
imply a tendency for consolidation decision making to be discouraged by the presenceof a financial crisis, but this eﬀect is not statistically significant.
As for two political variables of veto players and governmental fragility, both variables are negative, implying that decentralized decision making structure has hindered
consolidation decision making and radical change of fiscal management. But it is interesting that the values of the variable of institutional veto players are statistically significance, while those of governmental fragility are not. We will see that this tendency
is reversed for subsequent years of consolidation. This result shows that institutional
structure of separation of powers, including the presence of president, upper house, andfederal system (decentralization), has blocked the initiation of fiscal consolidation. As
for the governmental ideology variable, the sign is negative, contrary to the expectations,although the result is not statistically significant. We can understand that starting consolidation is something not specific to conservative parties, left wing parties might also
undertake consolidation, and there is no clear tendency toward fiscal consolidation thatwould be related to ideology. Seat share has a positive sign and is statistically significant.
This means that, for example, an overwhelming victory of governmental parties would
accelerate the start of a fiscal consolidation.
As for budget institutions, the variable shows a negative sign and is statisticallysignificant. As we discussed above, this does not mean that good budgetary institutions reduce the probability of undertaking a fiscal consolidation. Budget institutions
are institutions, thus it takes time until their influence on sound fiscal management becomes visible. We can understand that budget procedure is eﬀective for gradual fiscal
improvement, and that it can make a radical change of fiscal management unnecessary.
This explains the negative sign of the budgetary variable. To confirm the eﬀectivenessof budget institutions for fiscal discipline suggested by the previous studies, we add theresult of one simple regression trial in our Appendix A5. This is a regression using ourdata with the same empirical settings as those used in Hallerberg et al. (2006) (Twoway fixed eﬀect estimation for 29 countries from 1971 to 2010 on the diﬀerence of debt
to GDP ratio).

3.2

Factors Influencing the Continuation of Fiscal Consolidation

As for continuing fiscal consolidation (right hand side of Appendix A.4), all the control
variables of initial economic and fiscal conditions appear to have no statistically significant influence on the process. Positive output gap and negative structural growth18

might suggest the possibility of continuing consolidation when there is an expectationof prosperity and when there is a perceived structural economic problem, but this is
not a reliable result. The same uncertainty exists for the outstanding debt. Our results
might suggest that when the outstanding debt is high, the governments tend to stop
consolidation projects, but this is only a tentative conclusion.
No clear estimation results could be obtained for accommodative policies. The interest rate variable is negative, but with only 10 % significance. Positive money supply
and negative exchange rate have no statistical significance. On the contrary, the current
balance turns positive and is statistically significant. This might mean that export drive
can contribute to sustaining the fiscal adjustment. Financial crisis variables now turnnegative and significant, both for present crisis and past crisis, implying a tendency of
governments to avoid consolidation if there is a financial crisis.
As for political institutions, both veto players and government fragility variables
have negative signs as they do in analysis related to starting consolidation, but contrary
to the starting years of consolidation, during the ongoing consolidation the variableof institutional veto players does not have any statistical significance, while that ofgovernmental fragility is statistically significant. This may be because the break up ofa coalition government is a more important risk for continuing a fiscal consolidation,
than institutional setting of separation of powers. Besides, governmental ideology andseat share variables both have a positive sign with statistical significance. The moreconservative the government parties are, and the more the majority of the government
parties is secured, the longer the fiscal adjustment is likely to continue.
Although the variable of budgetary institutions has a negative sign with statisticalsignificance, as we mentioned earlier, this is not because relatively good budget procedure
hinders fiscal improvement, but rather because good budget institutions are likely to needless fiscal adjustment.
As we can see, the variable of budget institutions has a negative sign in the analysis
related to implementation of consolidation, while in the analysis related to success ofthe consolidation it must have a positive sign, as we will see in the following section.

4

Factors Influencing Success of a Fiscal Consolidation

Here we examine factors influencing the success of a fiscal consolidation using regression
approach (Appendix A.6). As we already mentioned, we include an output gap dummy
variable in our main estimation model (left hand side of A.6). However, we also describe
estimation without the output gap dummy in view of sensitivity analysis (right hand sideof A.6). We analyze the regression table A.6 mainly for the model with the output gap
dummy. Then we check the diﬀerence between the model with the output gap dummy
and the model without that variable, and if the estimation results are similar for the twomodels, we can conclude that including or excluding output gap dummy does not havemuch influence on the results of estimation. This check is used to know how much does
the endogeneity problem influence our estimation.
First of all, we must focus on two control variables for initial conditions, growth and19

debt. Typically those two variables pose problems for the method of comparative tables,
because successful fiscal consolidation episodes are likely to have initial conditions ofhigh growth and low debt. In regression, these two variables are confounding factors to
be controlled for, but with comparative table such control is not possible.
From the estimation result, we find that structural growth has a very limited influencein terms of size of the marginal eﬀect and z score. Growth rate must have a positive
coeﬃcient to be advantageous for successful consolidation. The sign of the variable turns
negative, but this is probably due to obscurity in estimation and in any case this is notvery important because z score is very small. Outstanding debt has a negative sign,
which is not contrary to the intuition, but in any case both marginal eﬀect and z scoreare very small. In total, our findings suggest that structural growth and outstanding
debt have a very limited influence on sustainability of fiscal consolidation.
Analysis of the previous studies, which use comparative tables, suggests that apparent success of the fiscal consolidation may be due to the influence of initial conditions, particularly structural growth rate and initial outstanding debt (Holden & Mitdjhell(2013)). However, our analysis based on the use of regression approach rejects
this hypothesis and excludes the concern. This facilitates reading of other variables
and drawing some policy relevant information, such as a conclusion that expenditurecut strategy is more advantageous than tax hike etc., because the influence of initialconditions is excluded.
Next we focus on the political variables. First we test the two variables of veto players
and governmental fragility that we have already used. The variable of institutional vetoplayers returns a very small marginal eﬀect and a very small z score. Its sign eventurns positive, contrary to our expectations, which implies that the influence of thisvariable (institutional structure for separation of power) is very weak. We found that
there is a certain degree of influence of this variable on decision making concerning
consolidation, as is suggested by a background theory of veto players, which tells usthat the existence of veto players hinder radical decision making. We use a sample ofconsolidation episodes that have already been decided upon and try to determine whatleads to sustainable cases, so it is understandable that the influence of institutional
factors, hindering decision making on ”sustainability” is likely to be weak.
The next political variable is governmental fragility. Here the size of marginal effect and z score is still not large enough, but it is much greater than for institutional
veto players. As we found in decision making analysis, governmental fragility might
be particularly potent in hindering the continuation of fiscal consolidation. Although
the continuation of a fiscal consolidation episode and the sustainable fiscal eﬀort after
the consolidation episode are two diﬀerent things, both phenomena are related to the
problem of breaking up of a coalition government, which is more probable when theideological gap between coalition parties is wider and which is likely to interrupt theprocess of fiscal adjustment.
We also use the lag variable of legislative elections, not because we find that elections
enhance the probability of successful fiscal consolidation, but because the fact that elections are already over might facilitate the fiscal sustainability after fiscal consolidation.

20

As we expected, the sign is positive, and the magnitudes of the marginal eﬀect and zscore are suﬃciently large (5 % significance).
The variable of budget institutions is also a political variable, although in a wider
sense, and we find that this variable shows a very strong positive eﬀect with a high zscore and a large marginal eﬀect (5 % significance). In the course of decision making
analysis the results showed a negative and statistically significant result for this variable.
This time the result was opposite. This time the analysis was conducted on the sample offiscal consolidation episodes that have already been decided upon. The virtue of budget
institutions is to improve fiscal situation in a continuous fashion, but this takes time.
This index includes a number of various factors with small individual contributions.
Besides, while a certain factor can be decisive at some point, another one becomes
decisive at another moment. So this variable is apt to maintain a good state of publicfinance, rather than radically change the fiscal state. The result of probit analysis clearlyshows the continuous character of the power of institutions.
Next we turn to the problem of consolidation strategy, when we must choose between
expenditure cut and tax hike strategies. The expenditure change variable during a
consolidation year returns a negative sign, which means that expenditure cut might
facilitate successful consolidation. Z score is −2.54, and the marginal eﬀect is suﬃciently
large for a non indicator variable. If we rely only on this variable, we would be inclined torecommend expenditure cut as a promising consolidation policy. However, the revenuechange returns a marginal positive eﬀect of a similar magnitude (−.0587vs.0559), eventhough it has only 10 % significance. Thus, although revenue change is not statisticallysignificant, the eﬀect of expenditure cut and that of tax hike appear similar. This goesagainst the conclusion of AAP that recommended the expenditure cut strategy rather
than tax hike for successful and expansionary fiscal consolidation.
We must emphasize that our conclusion is based on results obtained by controllingfor fiscal management after the consolidation episode, procedure missing in the previous literature including AAP. The signs or marginal eﬀects of related variables of post
consolidation fiscal management are not important, but controlling for them helps togive a neutral interpretation of the contemporary variables of expenditure and revenue.
Despite this limitation as control variables, we find that the size of the marginal eﬀect in
the revenue variable is relatively large, as compared to that of the expenditure variable.
Thus, we find that a mix of strategies involving expenditure and revenue changes could
have a relative tendency of postponing a tax hike, which might be advantageous forachieving government debt sustainability. Of course, this is just a ”tendency and is
not statistically supported.
Finally, we measure the influence of accommodative monetary policy using the Taylor
Rule as a standard. We take unity if the nominal short term interest rate is less thanthat dictated by the Taylor Rule. Our findings show that this influence is very strong.
If we compare the marginal eﬀect of accommodative monetary policy (here, the dummy
variable) with the marginal eﬀect of the financial crisis (contemporary) dummy, we
ll find that they are almost equal in magnitude, but have opposite signs. With one
percent significance, accommodative monetary policy has an undeniable influence on the21

success of fiscal consolidation. Thus, the recent economic decline implying that interest
rates hit the ZLB (Zero Lower Bound) suggests that further interest rate cut is diﬃcult
or impossible, while recent eﬀorts of European or Japanese monetary authorities tointroduce a negative interest rate have been hitting various real hurdles and limitations.
Thus, it would be reasonable to postpone consolidation until the monetary policy climate
recovers.
We inserted an output gap dummy in order to find out whether the success of fiscal
consolidation is dependent on the business cycle element after the consolidation episode.
The sign of the output gap dummy is positive, so a good business cycle after consolidationis, of course, advantageous for successful consolidation, although the size of the marginal
eﬀect is relatively limited for a dummy variable, as well as its z score (1.10). Thus,
as long as we include other control variables in our estimation, the influence of post
consolidation business cycle movement is noticeable, but not as large as we feared.
We might not need to be overly careful about the influence of this variable. Asa sensitivity analysis, we include a model without the output gap dummy. According
to this sensitivity analysis, almost all of the variables return similar signs and similar
magnitudes of marginal eﬀects. Only the variable of structural growth changes its signfrom positive to negative. However, estimation of this variable is so imprecise and its
marginal eﬀect and z score are so weak that we can consider this change of sign tobe an indication of imprecision and therefore safely ignore it. Thus, we conclude that
estimation is stable regardless the inclusion of the post consolidation output gap variable.
Below is an overview of our findings obtained as a result of this study on successful
fiscal consolidation.
• As for political variables, the variable of governmental fragility may have a certain
influence on fiscal sustainability after consolidation. The possibility of a break
up of a coalition government due to ideological gap between parties may threaten
continuous fiscal performance. Elections are also risky because a consensus among
the stakeholders that was reached before the elections could break up after elections
due to the a change in power distribution among the stakeholders after the event.
• Contrary to the results obtained for the implementation of fiscal adjustment, thevariable of budget institutions has a clear influence on the success of fiscal consolidation. Institutions tend to contribute to preserving a state of economy rather
than to helping with radical changes. Budget institutions are helpful when there isa need to continue good fiscal performance once it has been achieved by a radical
change of fiscal state that occurs when a project of fiscal consolidation is launched.
• The claim that expenditure cut strategy is advantageous compared to a tax hike,which has been long put forward by the authors including AAP, is not supported bythis study. Our empirical results show that the chance of success of expenditure cut
driven consolidation is almost the same as that of a tax hike driven consolidation.
This result is obtained by controlling for initial conditions and post consolidation
environmental changes using regression approach, that is, under research settings
diﬃcult to obtain when using conventional comparative tables. Thus, we suspect
22

that the claimed supremacy of expenditure cut strategy might be the result oflimitations of research methods of the previous studies.
• As for controlling for initial economic conditions and business cycle, estimation
results show that we don’t have to be too concerned that these factors might
influence estimation quality and hinder successful consolidation. Structural growthrate and initial outstanding debt have a very limited influence on the sustainabilityof public finance after consolidation. Besides, the business cycle movement after
consolidation has a limited influence on successful fiscal consolidation, as we saw
in sensitivity analysis. Thus, we can safely ignore these elements as they are notdecisive for success of the consolidation.
• On the contrary, other related policy and financial circumstances have much more
influence on the outcome of the fiscal consolidation. We must avoid fiscal consolidation in the middle of a financial crisis, if we measure the success of consolidation interms of debt stabilization after consolidation. On the other hand, the implementation of fiscal adjustment after a financial crisis is very advantageous, probably
because we can exploit the economic recovery process after the financial crisis to
succeed with fiscal consolidation. Accommodative monetary policy could have astrong influence on the success of fiscal consolidation, which is almost equal tothe influence of consolidation implementation in the middle of a financial crisis.
Thus, we cannot freely change monetary policy stance because this might seriously
damage the probability of success of the fiscal consolidation.

5

Illustrative cases

This paper analyzed political factors facilitating implementation and success of fiscal adjustment, with carefully controlling for environmental economic factors and accommodative policies. We have noted some important institutional elements, which contributed
either to the decision making of consolidation or to the fiscal sustainability after consolidation episodes. On the contrary, as far as we set suﬃcient and relevant control variables
under chosen estimation techniques, ”initial conditions” of fiscal consolidation have notinfluenced so much either implementation, or success of fiscal adjustment. However,accommodative monetary or exchange policy facilitated either initiation or continuationof consolidation, or otherwise permitted to achieve more easily fiscal sustainability moreeasily after consolidation.
This is an overview of our empirical results, although we also add some illustrative
discussions, to make the implication of our results clearer at this moment of post crisis
era when many countries are strugling to recover from World Financial Crisis.
First, let s take a look at the table A.8 in the Appendix, where we show all successful
consolidation episodes and also add two facilitating factors, ”Good Budget Institutions”and ”Accommodative Monetary Policy”. Although there are still other factors, which
influence the probability of success, these two variables are representative among facilitating factors. ”Good Budget Institutions” are introduced by setting budgetary index
23

(normalized 0 to 1) superior to 0.6 (nearly equivalent to the first quantile of the wholesample). ”Accommodative Monetary Policy” is introduced by using the variable of thetest whether the short term nominal interest rate in one of the two years after consolidation is inferior to what is dictated by the Taylor Rule. We mark consolidation episodeyears by ”*” for the former factor, and ”+” for the latter.
We can see that either good budget institutions or accommodative monetary policy
coexist with most of the successful consolidation episodes. In view of making a consolidation episode successful, we need one of these two conditions satisfied. Cases of successwithout any of the two conditions are rather rare.
Next, let us turn to more recent situations. Appendix A.9 shows a couple of variables
calculated for our sample countries in 2011. The first variable is CAPB change, which
was used to calculate fiscal consolidation episode in this paper (with newly defined CAPB
concept and real GDP trend calculated by Hodrick Prescott Filter). The second variable
is a dummy variable testing whether short term nominal interest rate is inferior to thevalue dictated by the Taylor Rule. The third is the variable of Budget Institutions
with one year lag, which we used in probit analysis for implementation and success of
consolidation. Year 2011 is not covered in our sample, so we don t have all the necessary
elements to judge the success of fiscal consolidation. Thus, we will see some signs ofsuccess from CAPB change (as if we change our consolidation definition from multiyear to single year), and some signs supporting monetary policy position, (although thedata is only for 2011, the situation could continue further). In fact, the data of budget
institutions are usually stable, thus we can safely conjecture the continuation of therelated variable.
On the basis of the available information it is diﬃcult to judge the relation between
consolidation success and facilitating factors, because in order to know this we need data
covering a longer period. However, we could oﬀer here some tentative argument to show
the key points of evaluating the relevance of launching fiscal consolidation during thisdiﬃcult period for the world economy.
First, let us take a look at the countries known for their sovereign debt crisis afterWorld Financial Crisis, such as: 4 Southern European Countries (SE-4: Greece, Italy,
Portugal, Spain), Ireland, and Japan, where so far no similar crisis has occurred, butwhich has the most serious debt problem judging by the magnitude of debt to GDP ratio(over 240 %). Among these countries, in 2011, some have already launched projects offiscal consolidation (if measured by single year definition of consolidation conventionallyused, say, by CAPB improvement of over 1.5 % per GDP), while others are still lingering
on. Ireland, Greece, Portugal show strong CAPB improvement, while Italy and Spain
have limited improvement, and Japan s public finance has even deteriorated in 2011.
Some movements appear to be merely superficial. For example, Portugal has shownstrong fiscal improvement in 2011, but otherwise its public finance has deteriorated
since 2008, and again in 2012 (that is, negative CAPB improvement). Greek fiscal
consolidation appears to span over 2011 and 2012 (CAPB deterioration had continued
in Greece before 2011), but it has reversed back again to negative CAPB improvementin 2012. Thus, one can hardly say that fiscal consolidation was implemented in these24countries around year 2011.
But in any case, monetary policy position of these countries is disadvantageous, judging from a dummy variable of accommodative monetary policy (that is, on the premisethat such disadvantageous position persists). The related variables for Greece, Ireland,
Italy, Japan, Portugal and Spain are all zero. Surprisingly, this variable is advantageous(with a value of unity in the table) for most other countries. In terms of accommodative
monetary policy this means that fiscal consolidation should be recommended for mostparliamentary democracies. It is not recommended for the 6 countries mentioned above
due to lack of advantageous policy environment. These countries have been widely publicized in the media because of their sovereign debt crisis or accumulated debts, andthey have also had economic damage afterwards, which might suggest us the need for a
prudent approach to the timing of launching a fiscal consolidation project.
However, we might be able to expect that with a good governance structure a country could overcome economic hardships and bring its public finance toward stabilization.
One of such typical elements of a good governance structure is represented by the budget
institutions. We can focus on the variable of budget institutions to ponder this possibility. Greece has drastically improved its budget institutions, so it has some possibilities ofa positive outcome. The score of Ireland s budget institutions is also very high, so it canovercome economic hardships and achieve a successful consolidation. On the contrary,
the score of budget institutions in other countries is at least mediocre (Italy, Spain) or
even very low (Portugal, Japan). Governance reform must be seriously considered forthese countries.
Except for these countries, most other countries have advantageous policy climate
in terms of monetary policy position. Among Central and East European countries, forexample, Czech, Hungary, Slovenia have disadvantageous policy climate, in terms of themonetary policy position (Hungary’s fiscal improvement appeared to be large in scale,but it deteriorated a year later with CAPB deterioration of −6.15%). These countries
also have mediocre budget institutions, or even very problematic ones, like in Hungary(where it scored .22). Even though most of these Central and East European countries
have undertaken fiscal adjustment, it is doubtful that this attempt is sustainable without
a profound reform of governance structure so far unattained during the process of transition from the communist rule. Fiscal governance reform must be seriously considered
and undertaken in such countries (the score of budget institutions is mediocre for Bulgaria and Lithuania, and very bad for Slovakia (.22) even though for the moment thesecountries are supported by advantageous monetary position climate). Even though mostof Central and East European countries have taken on fiscal consolidation, its final eﬀect
leading to fiscal sustainability depends crucially on completion of governance structurereform supposedly undertaken since the collapse of the communist regimes.

6

Conclusion

In this paper, on the basis of a review of recent critical studies on fiscal adjustments
we made an attempt to introduce rigorous control for initial economic conditions and25accommodative monetary policy or (contemporary or post consolidation) fiscal management with the aim of introducing a new approach to political economy study on decision
making and eﬀects of fiscal adjustments. As a result we have obtained relatively clear
results concerning implementation of fiscal consolidation. Our findings indicate that
institutional veto players influenced the year of starting a fiscal consolidation, while
governmental fragility had a role in determining whether consolidation continued thefollowing year or not. Seat share also exerted a certain influence on consolidation decision making. Although the impact of budget institutions was found to be negative,
possibly this is merely due to the fact that good budget institutions would need fewer
fiscal consolidation. This is in contrast with the results obtained in the analysis of theeﬀects of consolidation.
When it comes to the eﬀects of fiscal consolidation, that is, fiscal sustainability after
consolidation episodes, political economy factors are still likely to have some influence,but the results are less clear than in the analysis of consolidation implementation. Positive marginal eﬀect found for budget institutions in probit estimation means that they
contribute to a good budget process by stabilizing debt. Political variables might also
influence the success of consolidation, and the variable of governmental fragility implies
that a risk of breaking up of a coalition government might hinder fiscal sustainability
after consolidation (although the result is non significant). As for consolidation strategy,
expenditure cut is not particularly advantageous, compared to tax hike, for achieving
fiscal sustainability after consolidation episode.
These results imply that we may have to ponder reforms of constitutional level,or change political culture of a parliamentary democracy, for example, by introducing
reforms of political and budgetary institutions, if we hope to achieve fiscal consolidation(initiation and continuation) and its sustainable fiscal eﬀect. For example, we haveseen that institutional veto players hindered the starting of fiscal adjustments, whichmeans that presidentialism, bicameralism, federalism or too much decentralization must
be reconsidered. The variable of governmental fragility was shown to (negatively) influence continuation of a fiscal consolidation. Thus, we have more probability of continuing
consolidation when we have stabilized, if possible, a non coalition government. Thismight also be true for achieving debt sustainability after consolidation. Budget institutions are important to achieve the success (that is, stabilizing debt after consolidation)of fiscal adjustments. Budgetary reforms would be necessary for the countries, whichscore low in terms of budgetary index and need fiscal consolidation.
After introducing a new CAPB calculation method, which excludes measurement
error related to asset value movements and avoids reverse causality, and after replacing
comparative tables that cause serious problems in terms of controlling for initial conditions, our empirical studies show that, with respect to consolidation decision making andits success, the corresponding control variables were of little statistical significance. On
the contrary, some variables of accommodative monetary policies often exert a strong
influence on consolidation decision making and consolidation success.
Thus, with the reservation that we must wait for good moments to start and continue
fiscal consolidation when we can relatively easily manipulate monetary variables, we26

might as well seriously consider reforms of political and budgetary institutions if we hopeto succeed with starting a fiscal consolidation or assuring its success. This conclusion
was reached after controlling for previously overlooked elements, which might, however,deteriorate some of the important empirical results in case of a successful consolidation.

27

References[1] Alesina, A. & S. Ardagna(2010), ”Large changes in fiscal policy: Taxes versus spending”, Tax Policy and the Economy, 24[2] Alesina, A. & S. Ardagna(2012), ”The design of fiscal adjustments”, NBER working
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3[13] Fabrizio, S. & A. Mody (2010), ”Breaking the impediments to budgetary reforms:
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[15] Hallerberg, M., R. Strauch& J. von Hagen(2006), ”The design of fiscal rules andforms of governance in European Union countries,” Discussion Paper Series of
SFB/TR 15 Governance and the Eﬃciency of Economic Systems 150, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University ofMannheim, University of Munich.
[16] Heylen, F. & G. Everaert(2000), ”Success and failure of fiscal consolidation in the
OECD: a multivariate analysis”, Public Choice, 105, 103-124.
[17] Hjelm, G.(2004), ”When Are Fiscal Contractions Successful? Lessons for Countries
Within and Outside the EMU,” Working Paper No. 92, The National Institute of
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[19] IMF(2010), ”Will it hurt? Macroeconomic eﬀects of fiscal consolidation”, World
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Consolidation in the EU”, European Economy, Economic Papers, 320[21] Lassen, D. (2010), ”Fiscal consolidations in advanced industrialized democracies:
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Finance of Finland)

30

A

Appendix

A.1

List of Country/Year of Consolidation Episodes

Country
Australia
Austria
Belgium
Bulgaria
CanadaCzech
Denmark
Estonia
FinlandFranceGermany
GreeceHungary
Ireland
Italy
Japan
LatviaLithuania
Luxembourg
Netherlands
New Zealand
PolandPortugal
Romania
Slovakia
Slovenia
Spain
SwedenUnited Kingdom
Note

Year
86∗ , 87∗ , 88∗ , 95, 96∗ , 97∗ , 98∗ , 99∗ , 02∗ , 03∗

71∗ , 72∗ , 77, 78, 81, 87, 90, 91, 92, 95, 96∗ , 97, 00, 01∗ , 05∗ , 07, 08
74∗ , 82, 85, 87, 88, 89, 90, 00∗ , 01∗ , 06∗ , 07, 08
04∗ , 06∗ , 08∗∗∗
73 , 74 , 80, 81, 82, 86, 87, 88, 89, 90, 94, 95, 96∗ , 97∗ , 98∗ , 99∗ , 00∗ , 01∗
96, 97, 98, 04, 06, 07, 08
85∗ , 86∗ , 87∗ , 95∗ , 96∗ , 98∗ , 99∗ , 05∗
00∗ , 01, 02, 03∗ , 06
71∗ , 75, 76, 80, 81, 84, 85, 86, 88∗ , 89, 90, 96∗ , 97∗ , 98∗ , 00∗ , 01∗ , 06∗ , 07, 08
79∗ , 96, 01
73, 76, 77, 87, 96, 99∗ , 00, 05∗ , 06, 07, 08
91, 92, 94, 96∗ , 00, 05, 10∗
96 , 99∗ , 00∗ , 03, 04, 07, 08, 09
73, 74, 75, 80, 81, 83, 84, 88∗ , 90∗ , 91∗ , 96∗ , 99∗ , 00∗ , 05∗ , 06
76, 77, 82∗ , 83∗ , 90, 91, 92, 93, 94, 95, 96, 97∗ , 06, 07
74, 75, 80, 81, 82, 83, 84, 85, 86, 89∗ , 90, 91, 99, 01, 05, 06, 07, 08
06∗
93, 94, 97∗ , 00∗ , 01∗ , 07, 08∗∗
73 , 74 , 84, 85, 88, 90, 91, 96∗ , 98∗ , 99∗ , 00∗ , 01∗ , 08
87∗ , 88∗ , 91∗ , 94∗ , 95∗ , 96∗ , 00∗ , 01∗ , 02∗ , 05∗ , 06∗
92∗ , 99, 02, 06, 07
08
97, 98, 01∗ , 03∗ , 04∗
05∗ , 0874∗ , 75, 87, 88, 92, 99∗ , 00∗ , 01∗ , 02∗∗∗
71 , 75 , 76, 81, 84, 85∗ , 86∗ , 87∗ , 90, 95, 96, 97∗ , 98∗ , 01∗ , 05∗ , 07∗ , 08∗
73∗ , 74∗ , 79∗ , 80∗ , 81, 87∗ , 88∗ , 94, 95, 96, 97∗ , 98∗ , 99∗ , 00∗”*”Successful Consolidation

31

A.2

Descriptive Statistics of Variables
Variable
1.Output Gap(-)
2.Debt(-)
3.Growth(-)
4.Current Account Change(-)
5.Interest Rate(-)
6.Money Supply(-)
7.Exchange Rate(-)
8.Financial Crisis(-)
9.Financial Crisis(t)10.Veto Players(-)
11.Gov. Fragility(-)
12.Ideology(-)
13.Seat Share(-)
14.Election(+)
15.Budget(-)
16.Expenditure(t)17.Revenue(t)18.Ex.(+)
19.Revenue(+)
20.Interest Rate Dummy(+)
21.Output Gap Dummy(+)

Obs.
953
889
903
772
881
907
810
1160
1160
926
915
915
915
928
1160
790
790
806
806
909
973

Mean
0.21
51.25
3.17
-0.05
0.05
6.28
-1.04
0.13
0.09
1.35
13.88
-0.92
0.55
0.28
0.5
1.38
1.18
2.44
2.31
0.70
.60

Stan.Dev.
2.95
32.47
2.03
0.84
4.36
29.52
11.62
0.33
0.29
1.27
15.55
17.64
0.1
0.45
0.16
2.16
1.64
2.96
2.53
0.46
.49

Max
-15.62
4.15-10.96-4.65-58.91-165.72-93.01
0
0
0
0
-58
0
0
0.22
-8.69
-4.6
-21.34
-7.74
0
0

Min
21.41
180.83
11.1
4.73
26.19
511.86139.56
1
1
4
79.98
64.53
0.86
1
0.88
20.38
8.7
21.37
13.81
1
1

Note::”-”:One Year Lag,”t”,”t + 1”,”t + 2”:Data of the time t, t + 1, t + 2, ”+”:Change
from Consolidation Year during 3 Years or Mean of these 3 Years.

A.3

Variable Definition and Data Source

1.Output Gap(-):Calculated from real GDP and Our trend real GDP(OECD EO92)
2.Debt(-):Calculated from real debt standing and Our trend real GDP(OECD EO92)
3.Growth(-):Mean real growth rate of past 5 years(OECD EO92)
4.Current Account Change(-):Mean current account change of past 5 years(Worldbank
WDI & OECD EO92)
5.Interest Rate(-):Gap of real interest rate with US rate(IMF IFS)
6.Money Supply(-):Gap of growth rate of real money supply per our trend real GDP
with the same value of US(IMF IFS)
7.Exchange Rate(-):Growth rate of nominal eﬀective exchange rate(IMF IFS)
8.Financial Crisis(-):Dummy counting one if there has been at least one financial crisis
year during past 5 years(IMF Systemic Banking Crises Database)
9.Financial Crisis(t):Dummy counting one if there is financial crisis at consolidation
year(IMF Systemic Banking Crises Database)
10.Veto Players(-):Total of qualitative scoring(total 6 point) of presidential democracy(2),bicameralism(2), and federalism/decentralization(2)(CPDS, Wikipedia)
32

11.Gov. Fragility(-):Maximum ideology gap between governmental parties(Manifesto,
Wikipedia)
12.Ideology(-):Ideology of the party of prime minister(Manifesto, Wikipedia)
13.Seat Share(-):Seat share of governmental parties in parliament(Wikipedia)
14.Election(+):Dummy counting one if there has been at least one legislative election,
parliamentary or presidential(Worldbank Political Institutions Database)
15.Budget(-):0-1 normalization of 29 countries index inspired by Fabrizio & Mody (2010)
16.Expenditure(t):Cyclically adjusted primary expenditure per our trend real GDP(OECD
EO92)
17.Revenue(t):Cyclically adjusted revenue per our trend real GDP(OECD EO92)
18.Ex.(+):Idem with 15
19.Revenue(+):Idem with 16
20.Output Gap Dummy(+):Take unity if positive output gap in one of the following 2
years(OECD EO92)
21.Interest Rate Change(+):Take unity if nominal short term interest rate is inferior to
the dictation of Taylor Rule in one of the following 2 years(IMF IFS)

A.4

Factors for Fiscal Consolidation Implementation
Variable
Margin. Z Score
Dep.V ar. = Consol.
Output Gap
0.01071.03
Growth0.00010
Debt
0.0007
0.92
Interest−.0221∗∗∗
-3.26
∗∗
Money
.0038
2.32
Exchange−.0060∗∗-2.27
Curr.Acc.
.0577∗
1.88
Crisis(past)-0.0315-0.49
Crisis(present)-0.1224-1.63∗
Past adjustments
.0083
1.84
Veto Players−.0333∗∗-2.29
Gov. Fragility-0.0012-1.06
Ideology0-0.07
Seat Share.4947∗∗
2.29
Budget-0.4069−4.70∗∗∗
Observations
419
Mc-Fadden R2
0.28

Margin.

Z Score0.0274-0.0111-0.0009−.0191∗0.0029-0.0096.1711∗∗∗−.2328∗∗∗−.1799∗∗.0189∗∗∗-0.0184−.0039∗∗∗.0050∗∗∗.5952∗∗−.5927∗∗∗
238
0.51

1.58
-0.41
-0.86
-1.67
1.23
-1.37
2.59
-3.11
-2
2.63
-0.71
-2.34
2.94
2.18
-2.43

Note: Left hand side is marginal eﬀect, right hand side is Z score calculated
by cluster standard error, for each timing(starting year/continuing year).
10% significance ”*”, 5% significance ”**”, 1% significance ”***” calculated
by Z score.

33

A.5

Regression of Debt Standing per Trend GDP(Diﬀerence) on Budget Institutions(Two Way Fixed Eﬀect Estimation with Panel
Corrected Standard Errors(PCSE))

Debt(lag)
Growth(lag)Budget(lag)Observations
R2

A.6

Coef.
−0.03∗∗∗−0.99∗∗∗−5.53∗∗∗
889
0.10

PCSE
0.01
0.14
1.63

Probit Estimation for Successful Fiscal Consolidation(Output Gap)
Dep. = Success
Growth(-)
Debt(-)
Veto Players(-)
Gov. Fragility(-)
Election(-)
Budget(-)
Financial Crisis(-)
Financial Crisis(t)Expenditure(t)Revenue(t)Exp.(t+1,2)
Revenue(t+1,2)Taylor(+)
Output Gap(t+1,2)
Observations
Mc Fadden’s R2(With)
M.E.
Z-.0032-.09-.0001
-.05
.0026
.05
-.0003-1.13.0967∗∗
2.39.6972∗∗
2.23
∗∗
.3128
2.52
−.2954∗∗∗ -2.90−.0587∗∗ -2.54.0559∗
1.72-.0024
-.15
.0257
1.48
.3454∗∗∗
3.73
.0997
1.10
237
.21

(Without)
M.E.
Z
.0009
.03
-.0001
-.04
.0078
.14
-.0003-1.11.0987∗∗
2.39.7219∗∗
2.35
∗∗∗
.3270
2.70
−.3323∗∗∗ -3.62−.0587∗∗ -2.48.0577∗
1.74-.0075
-.49
.0310
1.79
.2891∗∗∗
3.95
237
.20

Note: Left hand side is marginal eﬀect, right hand side is Z score calculated by cluster standard error, for each estimation(with or without
output gap dummy). 10% significance ”*”, 5% significance ”**”, 1%
significance ”***” calculated by Z score.

A.7

Database of Budget Institutions

The following list is the budget institutions index of Fabrizio & Mody (2010), whichhave developed their own database starting from von hagen’s database, and integrated
their own qualitative evaluation of budget institutions, and East and Central European
countries as well. The budget institutions are classified by each phase of budget cycle,

34

governmental preparation(G), parliamentary discussion and vote(P), and administrative
implementation(I). Refer to Fabrizio & Mody(2010).
Table 1: Classification of Budget Institutions
No
G1
G2
G3
P1
P2
P3
I1
I2
I3
I4

Index
General constraint
Agenda Setting
Negotiation Structure
Amendment to the budget bill
Initial vote on the total
Confidence voteSupplementary budgets
Budgetary transfer
Interannual rollover
Freeze or Cancellation of budget items by ministry of financeWe integrated our own budgetary index based on documentary research and fieldwork
into Fabrizio & Mody(2010). We referred to von Hagen(2005) when it comes to Japanesebudget institutions and balanced qualitative observations with already scored indices.All
the data of 29 countries are shown in Nakanishi(2017).
Table 2: Budget Institutions of Additional 4 Countries
Australia(85 ∼)
CanadaJapan
New Zealand(85 ∼)

G1
2
∼97
0
2
∼94
0
0
3
0∼93

G2
1

P1
0

P2
0

P3
4

I1
4

4

0

4

4

2

G3
2
∼82
0
4
∼94
0
0

0

0

4

0

2
1∼93

2
0∼88

0
4∼95

0

4

4

4
1∼94

35

I2
1.28
2.56∼85
1.28
3.2∼92
3.2

I3
1.33
4∼85
1.33
4∼86
2.66

I4
0

1.92
3.2∼88

4

0

0
0

A.8

List of Country/Year of Successful Fiscal Consolidation Episodes
with or without Facilitating Factors

Country
Australia
Austria
Belgium
Bulgaria
CanadaCzech
Denmark
Estonia
FinlandFranceGermany
GreeceHungary
Ireland
Italy
Japan
LatviaLithuania
Luxembourg
Netherlands
New Zealand
PolandPortugal
Romania
Slovakia
Slovenia
Spain
SwedenUnited Kingdom
Note

Year
86+ , 87+ , 88, 96, 97+ , 98+ , 99+ , 02+ , 03+
71+ , 72+ , 96, 01∗ , 05∗+
74+ , 00+ , 01+ , 06∗+
04+ , 06+ , 08+∗+∗+∗+
73 , 74 , 96 , 97∗+ , 98∗+ , 99∗+ , 00∗+ , 01∗+85, 86, 87, 95+ , 96+ , 98+ , 99+ , 05+00∗+ , 03∗++++71 , 88 , 96 , 97+ , 98+ , 00+ , 01+ , 06+
79∗+
99, 0596++
96 , 99+ , 00+
88+ , 90, 91+ , 96∗+ , 99∗+ , 00∗+ , 05∗+
82+ , 83, 97
89+
06+
97∗+ , 00∗+ , 01∗+++
73 , 74 , 96+ , 98+ , 99+ , 00+ , 01+
87, 88, 91, 94, 95∗ , 96∗ , 00+ , 01+ , 02+ , 05+ , 06+
92+
01+ , 03+ , 04+
05+
74, 99+ , 00+ , 01+ , 02+∗∗++
71 , 75 , 85 , 86 , 87+ , 97+ , 98∗+ , 01∗+ , 05∗+ , 07∗+ , 08∗+73∗+ , 74∗+ , 79∗+ , 80∗+ , 87∗+ , 88∗+ , 97∗ , 98∗ , 99∗ , 00∗+”*”Good Budget Institutions”,”+”Accommodative Monetary Policy

36

A.9

List of Country/CAPB Change with Facilitating Factors in 2011
Country
Australia
Austria
Belgium
Bulgaria
CanadaCzech Republic
Denmark
Estonia
FinlandFranceGermany
GreeceHungary
Ireland
Italy
Japan
LatviaLithuania
Luxembourg
Netherlands
New Zealand
PolandPortugal
Romania
Slovakia
Slovenia
Spain
SwedenUnited Kingdom

CAPB Change
1.9
2.3
.2
1.2
1.4
3.0
.8
4.2
2.2
2.0
4.0
2.7
7.8
16.9
.9
-1.8
2.8
.2
.9
1.4
2.1
3.1
7.5
2.2
2.2
.0
.7
.8
3.4

37

Monetary Policy
0
1
1
1
1
0
0
1
1
1
1
0
0
0
0
0
1
1
1
1
0
1
0
1
1
0
0
1
1

Budget
.39
.62
.60
.51
.72
.54
.50
.76
.50
.77
.56
.68
.22
.72
.51
.30
.61
.49
.80
.51
.52
.60
.38
.61
.24
.47
.51
.72
.81