Macroeconomic Effects of Fiscal Consolidation in Emerging Economies: New Narrative Evidence from Latin America and the Caribbean

We estimate the effects of fiscal consolidation on economic activity based on a new narrative data set for 14 emerging economies in Latin America and the Caribbean (LAC). Following a Romer and Romer identification approach, we examine contemporaneous policy documents to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to the economic cycle. We find that a fiscal consolidation of 1% of GDP reduces real GDP by, on average, 0.9% in two years. The estimated effects are close to those we find for advanced economies based on a comparable narrative data set. We also find a strong “twin deficits” relation in LAC, with fiscal consolidation triggering an adjustment of the current account balance and depreciation of the real exchange rate that are more pronounced than in advanced economies.