Sustainability of public finances in OECD countries

2. Lessons from past fiscal consolidations

2.1. How to identify a fiscal consolidation episode

Fiscal consolidation is the term used to describe the effort of governments to improve public financial health through deliberate policy measures. The emphasis with fiscal consolidations is that governments do not solely “grow their way” to a healthier fiscal position due to favourable external conditions, but actively engage in policies to achieve such improvement.1

However, distinguishing between genuine fiscal consolidation efforts and the impact of favourable external conditions presents analytical challenges. Such external factors include cyclical revenue increases (such as higher corporation tax receipts during economic expansions), automatic reductions in mandatory spending (like decreased unemployment benefits), and the “snowball effect” whereby the differential between interest rates and GDP growth influences debt dynamics. They often constitute critical success factors in debt reduction episodes, making it difficult to isolate the contribution of deliberate policy measures.

Therefore, to assess whether countries are undergoing fiscal consolidations, two approaches are generally used, which are sometimes combined:

• The first is quantitative. The most commonly used quantitative indicator is based on consecutive positive changes in the cyclically adjusted primary balance (CAPB). The CAPB is the difference between government revenue and non-interest expenditure, adjusted to remove business cycle effects. Because of this, it is likely to better capture the fiscal stance and effort of governments – although the process of removing business cycle effects creates its own issues.2 Moreover, the CAPB approach cannot perfectly separate consolidation efforts from the influence of external economic conditions.

• The second approach is qualitative, or narrative-based. It involves looking through budget documents, official government communications and international organisations’ publications to see if a consolidation of some form is being discussed (Adler et al., 2024[5]; Romer and Romer, 2004[6]).

2.2. Main types of fiscal consolidation measures

Fiscal consolidation requires making a range of policy decisions on how consolidation objectives will be achieved, including: determining the scale of deficit reduction needed; timing the start, pace and duration of consolidation efforts; and deciding whether to frontload (most adjustments happen early in the consolidation period) or backload (most adjustments happen later) policy measures. All these decisions should be made in light of expected economic and social impacts. Finally, policymakers must also determine if the PFM system can support the consolidation efforts, or requires reforms.

The choice between revenue increases and spending cuts (or a combination of both) is one of the key decisions for decision makers, with implications across economic, fiscal, and political dimensions:

• Expenditure cuts typically involve reducing discretionary or mandatory government expenditures in real or nominal terms. For example, freezing funding for social welfare programmes (so that expenditure falls in real terms) or reducing investment spending (expenditure falls in nominal terms).

• Public sector efficiency reforms, a subset of expenditure cuts, involve restructuring government operations through digitalisation, administrative consolidation, and regulatory simplification to optimise resource allocation and enhance service delivery.

• Revenue enhancements involve increasing government income through various mechanisms, for instance tax rate increases, base broadening, or improving tax compliance.

2.3. Success factors for consolidation

When fiscal consolidation has been decided and implemented, the next question is how to determine whether it is successful or not. There are two main approaches to determining success in the literature (Balasundharam et al., 2023[7]):

• The ex ante (objective) approach assesses whether outcomes match the originally announced consolidation plans.

• The ex post (outcome) approach focuses on whether consolidations achieve minimum thresholds of improvements in fiscal indicators over specified periods.

Estimates of success rates of past fiscal consolidation exercises differ across the literature - reflecting the different approaches discussed above in determining success.

Recent comprehensive research generally highlights shared elements of what determines a successful fiscal consolidation episode (Balasundharam et al., 2023[7]; Pina, Hitschfeld and Borowiecki, 2023[8]; World Bank, 2024[9]; Hemmerlé et al., 2023[10]).

2.3.1. External determinants of consolidation success

External conditions significantly influence consolidation success. Favourable exchange rates and both global and domestic growth conditions are all amongst the factors that can drive debt reduction and contribute to successful adjustment. This is due to both the fact that higher growth means the debt-to-GDP ratio falls (denominator effect) and because higher growth or more favourable exchange rates can lead to higher government revenues and potentially reduced mandatory spending (e.g. on employment benefits). Price inflation has also historically contributed to reducing the real cost of public debt, although this has tended to be a more painful adjustment for consumers, businesses, and creditors.

Another factor that can be considered “external” is broad-based political support, which significantly enhances consolidation prospects. Key factors include having parliamentary majorities, newly-elected governments with fresh political capital, and unified party control. Coalition governments tend to face greater challenges due to consensus, building requirements, though they can achieve broader buy-in when successful.

2.3.2. Internal determinants of consolidation success

Design

Large consolidations generally require both revenue and expenditure measures, though the optimal mix depends on initial conditions. Revenue-raising measures could be more effective in developing countries where revenue-to-GDP ratios are modest (Balasundharam et al., 2023[7]), while expenditure-based consolidations may be more appropriate where government size is already large.

Evidence suggests that – except in cases of high and sharply rising debt levels and a low-growth environment – gradual consolidations were more effective or sustainable (Escolano, Jaramillo and Mulas-Granados, 2018[11]; Molnar, 2012[12]). The presence of sustained primary surpluses was a key feature of successful consolidations. However, gradual implementation of fiscal consolidations should be combined with decisive and timely decision-making on fiscal consolidation measures (European Commission, 2025[13])I.

Finally, consolidations that adequately address distributional concerns also tend to be more sustainable. This requires targeted social protection for the most vulnerable, progressive burden-sharing across income groups, and attention to regional and sectoral impacts. For example, Woo et al. (2013[14]) find that progressive taxation and targeted social benefits and subsidies introduced in the context of revenue-side fiscal consolidation can help offset some of the negative distributional impacts of consolidation. Conversely, failure to address these distributional concerns could undermine political support and lead to reversal of reforms.

Fiscal institutions

The literature emphasises that fiscal consolidation is more likely to succeed when implemented with appropriate fiscal institutions. For example, Heylen, Hoebeeck and Buyse (2013[15]) find that OECD countries with more developed and efficient government institutions will be more effective in bringing down debt with a fiscal consolidation programme. Mulas-Granados, Onrubia and Salinas-Jiménez (2009[16]) find that the adoption of new fiscal institutions by Eastern European countries joining the European Union in the 2000s aided with fiscal consolidation efforts also required in the accession process. Lastly the International Monetary Fund (2014[17]) found that G20 countries with stronger medium-term frameworks, performance budgeting systems and intergovernmental fiscal arrangements were quicker to announce fiscal consolidation plans post-GFC and better protected public investment within these plans.

Several fiscal tools have proven particularly valuable in recent decades:

• Fiscal rules provide governments with frameworks to guide decisions for starting fiscal consolidation by setting limits on debt, deficits, or expenditures. Chrysanthakopoulos and Tagkalakis (2023[18]) find that a fiscal rule which incorporates both strict and flexible features increases both the probability to initiate and successfully complete a fiscal consolidation. Moreover, a comprehensive survey of the empirical literature in 2024 found that fiscal rules are associated with improved fiscal performance and can support fiscal consolidations as they provide early and credible signals for the need for fiscal adjustment (Brändle and Elsener, 2024[19]).

• Medium-term expenditure frameworks have proven instrumental in successful consolidations by showing medium-term fiscal pressures and providing the frame for deciding and explaining where savings could be achieved. For example, Tanaka (2003[20]) highlighted the early potential for medium-term fiscal planning on improving fiscal consolidation outcomes in Japan.

• Spending reviews have been a key element of the fiscal consolidation toolkits in most countries by providing a framework for governments to identify areas where spending can be cut or reallocated. For example, in Ireland, spending reviews played an important role in fiscal consolidation efforts post-GFC (Kennedy and Howlin, 2016[21]).

• Independent fiscal institutions (IFIs) increasingly play a role in successful consolidations by increasing transparency and accountability, independently communicating the fiscal context, ensuring more accurate macroeconomic forecasts, monitoring adherence to rules, and providing policy costings and long-term sustainability analysis. Chrysanthakopoulos and Tagkalakis (2023[18]) find that IFIs with enhanced tasks and instruments are associated with successful fiscal consolidations. More generally, Wildowicz-Giegiel (2019[22]) finds, through a review of the literature, that IFIs are a useful mechanism of introducing indirect social control over government revenues and expenditures.

Expenditure shift

Past consolidation efforts often relied on across-the-board spending cuts. Evidence from successful debt reduction episodes shows, however, that the key on the expenditure side lies not in whether to cut spending, but in how (see for example Alesina, Favero and Giavazzi (2015[23]) and what (see for example Cournède, Goujard and Pina (2013[24]) to cut. As this paper shows through the case studies in section ‎4.4., recent consolidations have moved in this direction.

Programme-specific consolidations, grounded in a detailed review of the programme to find efficiency gains and expenditure reprioritisation opportunities – the shifting of expenditures as opposed to across-the-board spending reductions – are likely to be more effective, transparent, and less likely to undermine public sector performance (World Bank, 2024[9]).

Moreover, expenditure restraint should be accompanied by growth-friendly shifts in expenditure composition (Pina, Hitschfeld and Borowiecki, 2023[8]). Productive, investment-focused expenditure should be distinguished from operational current expenditure, and expenditure restraint should focus on this current expenditure (Guichard et al., 2007[25]). Existing capital investments can also be looked at to ensure the best use of existing infrastructure, thereby meeting public service expectations while also managing and potentially reducing expenditure.

However, there may be some situations where non-targeted expenditure consolidation is required. For example, if political agreement cannot be made on which programmes to focus on, across-the-board spending reductions may be seen as a less unacceptable option. Moreover, in the rare case where a country requires urgent action, across-the-board spending reductions may be required as effectively targeting expenditure reductions takes time.

Commitment and communication

Programme design must reflect credible commitment to fiscal reforms. A credible plan eases financing constraints and allows for greater policy space. Research demonstrates that markets respond more to legislative adoption of consolidation measures than to mere announcements, highlighting the importance of formal institutional commitment (see for example David, Guajardo and Yepez (2019[26])).

An effective communication strategy proves essential for consolidation success. Governments must clearly explain the necessity for adjustment, present policy choices and trade-offs transparently, and maintain regular engagement with stakeholders.

For instance, the Canadian experience in 1994-1995 demonstrates the value of an effective communication strategy. Before this, sustained coverage of the urgency of addressing Canada’s debt problems by international institutions, international rating agencies, Canadian research institutions and the media raised public awareness of the issue (Sancak, Qian Liu and Nakata, 2011[27]). Moreover, the Government, in October 1994, published a report entitled “A New Framework for Economic Policy” to further educate the public about the importance of fiscal consolidation. Key messages of this report were spread through national and regional conferences, in public debates around the country, and in meetings held with interest groups from mixed backgrounds (Sancak, Qian Liu and Nakata, 2011[27]). This communication strategy contributed to Canadians’ understanding of the opportunity cost of high debt and the intergenerational equity concerns.3

Notes

← 1.  When interest rates are lower than GDP growth rates, this so-called snowball effect contributes directly and positively to debt reduction, effectively supporting consolidation efforts. OECD analysis has shown that for OECD countries, favourable snowball effects – driven by low real interest rates and improved cyclical conditions – have been crucial contributors to successful debt reduction, alongside primary balance improvements in many cases (Hemmerlé et al., 2023[10]).

← 2.  This is because it depends on the measurement of potential GDP and, relatedly, the output gap, which faces a number of measurement issues and is often subject to numerous revisions. See for example (Koske and Pain, 2008[58]).

← 3.  Another and more recent example in a non-OECD country is the Economic Programme Oversight Committee in Jamaica, which was created in 2013 to provide an independent oversight of fiscal, monetary and financial sector indicators underpinning a funding agreement with the IMF (Jamacia Information Service, 2016[59]). A key goal of the committee was to communicate the plan to the public, ensuring they understood the targets of the agreement (Jamacia Information Service, 2016[59]). They did this through social media campaigns, by publishing articles in newspapers, and through press conferences (Jamaica Information Service, 2018[60]), as well as through the organisation of “community meetings”. The objective of the community meetings was to ensure that the government “talk to the people, hear what they have to say and raise their awareness” (Jamaica Information Service, 2017[61]). The government later highlighted the “pivotal role” this committee played in “embedding fiscal consolidation in the Jamaican consciousness” (Jamaica Information Service, 2024[62]).