Expansionary Fiscal Consolidations: New Evidence from Turkey

Fatih Ozatay

No 406, Working Papers from Economic Research Forum

Abstract: After the February 2001 crisis, Turkey started to implement a new economic program. One of its aims was to reduce public debt that had jumped to a record high level. The resulting fiscal consolidation was rather exceptional. By the end of 2006, public debt-to-GDP ratio had declined by 43 percentage points. Despite this outstanding fiscal consolidation, the average growth rate attained in this period was almost twice that of the long-term growth rate. Given that shallowness of the Turkish financial markets had lead to credit constraints, it was tempting to study the reasons behind this performance. We argue that fiscal consolidation sharply reduced default risk, increased business confidence and improved banks’ and nonfinancial firms’ balance sheets, causing, in turn, a significant rise in credit supply and demand. Improvement in the private sector’s balance sheets and a decline in the option value of waiting, both together, boosted private sector demand.

Pages: 26
Date: 2008-01-06, Revised 2008-01-06
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