Fiscal consolidation, what does it mean really?

There are a few ways you can look at the term fiscal consolidation. Fiscal consolidation is often (in IMF-speak) equated with lower spending and higher revenues, which are policy instruments not outcomes. A more rational way of looking at consolidation is that it is about lower deficits and debt, which are outcomes. The point is that in general it is expansionary fiscal policy (higher spending and lower taxes) that lead to fiscal consolidation (lower deficits and debt), since expansionary policies increase income and revenue.

Hence, lower spending and higher taxes should be properly called fiscal austerity. And austerity, even if you do not follow functional finance, is contractionary. Mind you, it is not just the IMF that confuses consolidation with austerity.

Larry Summers in his recent op-ed on British economic policy says that:

"Britain must change the pace of fiscal consolidation to stand a chance of avoiding a lost decade. Rather than starving public investment, now is the time to add to confidence by making plans for structural reforms to contain the growth of public consumption spending over time. It is also time to take overdue measures to promote exports and, after years of appropriately low investment, to restart housing investment. But when demand is needed for growth and the private sector is hanging back, the first priority must be for the public sector to stop exacerbating the contraction."

Yes, he wants more spending (or lower taxes, God knows). But not much. Note that this continues to be the position of the IMF, even if the IMF has sort of admited that fiscal multipliers are larger than they previously thought (something that has made Krugman very happy; here too). In the last IMF Fiscal Monitor (October, 2012) you can read:

"With downside risks to the global economy mounting, policymakers must once again tread the narrow path that will permit them to continue strengthening the public finances while avoiding an excessive withdrawal of fiscal support for a still-fragile economic recovery."

I for one think that Europe and the US need a huge fiscal stimulus, and forget about consolidation. Consolidation is the result of economic growth and fiscal expansion is the best way to get it.

PS: And by the way, that's what was said in the Trade and Development Report 2011, which basically was a reply to the IMF's lukewarm pro-austerity views.