Cutting government spending to reduce national debt actually makes the debt-to-GDP ratio higher in the short term.
April 25, 2026
Original Paper
Does Fiscal Consolidation Reduce Public Debt? Evidence from the European Union Using Local Projections
SSRN · 6614958
The Takeaway
Fiscal consolidation backfires by shrinking the economy faster than it reduces the debt. When a government cuts its budget, the total economic output falls and investors demand higher interest rates on loans. These two factors combine to make the country's debt burden look even larger than before the cuts. Most policy makers assume that spending less is the most direct path to financial health. The data from the European Union proves that this common sense approach often achieves the exact opposite of its goal. True debt reduction requires balancing cuts with the need to keep the economy growing.
From the abstract
<p>We examine whether fiscal consolidation reduces public debt, using local projections difference-in-differences on 126 consolidation episodes in the EU-27 between 1996 and 2024. Entering consolidation raises the debt-to-GDP ratio in the short run rather than lowering it. A decomposition of debt dynamics traces the pattern to a widening interest–growth differential and to stock-flow adjustments that together more than offset the improvement in the primary balance. Two transmission channels sust