Afternoon Must-Read: Antonio Fatas: The (Very Large) Permanent Scars of Fiscal Consolidation:

Antonio Fatas: The permanent scars of fiscal consolidation: “I… look at the actual change in potential output during those years (2010-11)…

…as presented in the April 2014 IMF World Economic Outlook. Comparing this figure to the forecast done back in April 2010, we can calculate for each country the forecast error associated to potential output growth. Most models assume that there should be no correlation between these two numbers. Fiscal consolidations affect output in the short run but not in the long run…. Fiscal consolidations have led to a large change in our views on potential output… around -0.75…. This number is very large and it provides supporting evidence of the arguments made by DeLong and Summers regarding the possibility of fiscal contractions leading to increases in debt via the permanent effects they have on potential output…