Assessing the Credibility of Fiscal Reforms: An Application to the U.S. Budget Sequestration Spending Cuts

Every now and then countries get hit by shocks that imply that the government intertemporal budget constraint will have to be satisfied either by not honoring the outstanding public debt in the real terms implied by the... [ view full abstract ]

Every now and then countries get hit by shocks that imply that the government intertemporal budget constraint will have to be satisfied either by not honoring the outstanding public debt in the real terms implied by the inherited fiscal policy configuration, or by changing that configuration with sweeping fiscal reforms. The success of the latter may hinge critically on their credibility. Policymakers might benefit, therefore, from methodologies that address that issue in actual fiscal reform experiences. This paper proposes one such methodology, inspired by the Business Cycle Accounting approach, and shows its usefulness by applying it to a recent fiscal reform episode: the across-the-board cuts of discretionary government spending triggered in the U.S. in 2013 by a so-called budget sequestration procedure. This fiscal policy change was meant to rein on projected unsustainably high fiscal deficits by reducing the U.S. government purchases of goods and services to historically low levels. The examination of the evidence with the proposed methodology suggests that economic agents did not expect the spending cuts to be as large as implied by the budget sequestration reform, supporting the conjecture that the U.S. will have to rely on other measures to avert a fiscal crisis in the future.