Does Uncertainty Matter for the Fiscal Consolidation and Investment Nexus?

This research paper investigates whether there are nonlinearities in the relationship between fiscal consolidation and investment. To achieve this, we consider the overall state of the economy, as represented by the level of uncertainty. We analyzed a sample of 27 OECD countries from 1996 to 2019 and identified two different regimes of low and high uncertainty. We found that the relationship between fiscal policy and investment is significantly different in these two regimes. In the low uncertainty regime, fiscal tightening does not significantly affect investment. In contrast, in the high uncertainty regime, fiscal tightening harms investment, which is three times larger than in the low uncertainty regime. Our results are robust and have been confirmed through a range of sensitivity tests.