To what extent does hitting the fiscal brakes slow down the economic car? This debate, which has been going on for many years, has come back to the forefront with the new agreement between Greece and its creditors because it targets a significant swing in the primary balance (the government budget balance excluding interest charges), from a deficit of about 1% of GDP to a surplus of 3,5% by 2018 (European Commission data).

The following chart shows the relationship for Eurozone countries between the cumulative change in the primary balance and the cumulative change in real GDP. The latter, represented on the vertical axis, shows the ratio of real GDP for 2015 (based on IMF forecasts) and its level in 2008. A number above 1 implies that on average growth has been positive, though it doesn’t show the profile of GDP over this period. The primary balance is shown on the horizontal axis. To be more precise it shows the cumulative change in the cyclically adjusted primary balance since the year in which the low point was reached (so when the deficit reached a peak) and 2015 (for which the IMF forecasts are used). For all countries, the number is positive which means that the primary balance has improved. The cyclically adjusted balance is used to show the discretionary effort undertaken by governments to rein in their budget deficit.


Different comments can be made:

  1. As a caveat, the number of observations is rather limited, so this influences the quality of the regression. Moreover one may wonder whether Greece should be treated as a special case (this would influence the slope of the regression line)
  2. The intercept of the regression line shows that in the absence of any change in the cyclically adjusted primary balance, the cumulative GDP growth since 2008 would have been 5,6%
  3. In many countries the cumulative adjustment effort was below 4% of GDP, implying an, on average, limited annual effort (although the cumulative effect makes any additional effort harder and harder to achieve)
  4. On the question whether fiscal adjustment weighs on growth, the answer seems clear. The coefficient for the change in the cyclically adjusted primary balance and the change in GDP is 0,0104. This means that an improvement of the primary balance of 1 percent of GDP lowers the cumulative GDP growth with about 1 percentage point. The t-statistic for this coefficient is -2,77, so it’s quite significant. The drag of fiscal adjustment on growth may temporarily even be bigger considering that in this chart period averages are used. This result does not mean that fiscal adjustment should be avoided. It does suggest that the negative impact on growth should be taken into account in the design of fiscal, monetary and even structural policy.