The dynamic effects of fiscal consolidations on income distribution: evidence for Spain over 1980-2020

Abstract: Based on the Spain’s annual and quarterly time series from 1980 to 2020, this paper presents the first case study on the dynamic effects of fiscal consolidation episodes on income distribution and the mechanisms driving the specific dynamics of the distribution. By estimating impulse response functions via Local Projections by Jordà (2005), I find supportive evidence of the increase in income inequality in the aftermath of consolidation episodes. I also find historical divergence between consolidation intention and action of the Spanish government represented by the heterogeneity in the effects on income inequality of the “conventional” and “narrative” (Devries et al., 2011) approaches of consolidation identification. Specifically related to the design of the consolidation program, expenditure-based plans appear to favour less the low part of the income distribution. The reactions of unemployment and wages appear to explain the distribution’s low and medium part dynamics, whilst stock prices help explain the dynamics of the richest share. Also, these reactions highly depend on the prevailing business conditions. These results are robust to multiple specifications regarding alternative lag parameterizations, the effects of overlapping consolidation episodes, and the omission of controls.