TURNING THE FISCAL TANKER: THE ROLE OF SPENDING RIGIDITY IN ADJUSTMENT

Luiz de Mello and Joao Jalles

No 2026/0407, Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa

Abstract: This paper investigates how spending rigidities—captured by the government wage bill—affect fiscal adjustment across advanced, emerging market and low-income economies over the period 1980–2023. Building on a simple model of fiscal adjustment under rigidity, we show that a larger wage bill constrains governments’ ability to undertake discretionary consolidation in response to debt pressures. Empirically, higher wage bills (in relation to GDP) are systematically associated with smaller improvements in the cyclically adjusted primary balance and lower probabilities of consolidation. Adjustment in such settings occurs disproportionately through cuts to flexible expenditure items, notably public investment, rather than through revenue-side measures. Political cohesion enhances the likelihood and size of adjustment, but its effectiveness diminishes when spending is rigid. These results remain robust to alternative measures of discretionary action, estimation methods and sample definitions, including instrumental variable specifications and Hamilton-filter-based cyclicality adjustments. The findings underscore that fiscal sustainability hinges not only on macroeconomic fundamentals but also on the structural composition of expenditure and the political capacity to overcome rigidity.

Keywords: fiscal adjustment; spending rigidity; wage bill; political economy; fiscal consolidation. (search for similar items in EconPapers)
JEL-codes: E62 E63 H50 H62 H63 (search for similar items in EconPapers)
Date: 2026-02
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