What is Fiscal Consolidation?

Fiscal consolidation is a term that is used to describe the creation of strategies that are aimed at minimizing deficits while also curtailing the accumulation of more debt. The term is most commonly employed when referring to efforts of a local or national government to lower the level of debt carried by the jurisdiction, but can also be applied to the efforts of businesses or even households to reduce debt while simultaneously limiting the generation of new debt obligations. From this perspective, the goal of fiscal consolidation in any setting is to improve financial stability by creating a more desirable financial position.

Fiscal consolidation is important to any type of government fiscal policy that focuses on the elimination of debt. In order for the policy to function properly, it must consider the total cost of essential expenses and identify ways to generate as much benefit from those purchases as possible. This often means creating procedures that help to eliminate waste, effectively increasing the efficiency of the consumption of the goods and services purchased. Doing so helps to minimize the amount of new debt that is created as a result of making purchases.

At the same time, fiscal consolidation also requires identifying ways to trim existing debt when and as possible. This often involves making use of any surplus to incrementally retire that debt load. Since surplus is more likely to exist when spending for additional goods and services is kept to a minimum, the organization has the ability to make the most of any income current received, allocate enough funds to cover essential expenses, and divert the rest to settling older debt. Over a period of time, this dual approach to debt and debt generation results in a high level of operational efficiency with only a minimum of debt. For individual consumers and businesses, this often translates into a higher credit rating that in turn makes it possible to finance future purchases at more equitable rates of interest.

There are a number of pros and cons of fiscal consolidation noted by proponents and critics. Supporters note that while this process can be difficult, the end results are ultimately in the best interests of all concerned. Detractors note that should the process be so stringent that it eliminates the potential for responding to current market conditions in order to trigger growth, opportunities are lost that cannot be recovered at a later date. Both supporters and critics often provide case studies of instances in which the methods of fiscal consolidation have proven effective and beneficial, as well as detrimental in either the short-term or the long-term.