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We build a small open economy RBC model with financial frictions to analyze the incidence of expansionary fiscal consolidations in emerging market economies (EMEs). We calibrate the model to India, a proto-typical EME. We show that a spending based fiscal consolidation has an expansionary effect on output. In contrast, tax based consolidations are always contractionary. Either measure of consolidation, however, tends to increase the fiscal deficit and therefore the sovereign risk premia in our framework. Our findings support the results in the IMF WEO (2010), that tax based consolidation measures are more costly (in terms of GDP losses) than spending based consolidations in the short run. We identify new mechanisms that gird the dynamics of fiscal reforms and their implications for successful fiscal consolidations.
