Question

What happens to aggregate consumption if the fiscal consolidation was undertaken by reducing G? And in the case it was realized by increasing T?

Answer 1

In both cases, aggregate consumption will decrease.

When G decreases, aggregate demand directly decreases by more than the amount of fall in G due to spending multiplier effect. When T increases, aggregate demand decreases due to a decrease in disposable income, which lowers personal consumption expenditure, by more than the amount of rise in T due to tax multiplier effect. However, since spending multiplier is higher than the absolute value of tax multiplier, the decrease in aggregate consumption is higher for a decrease in G compared to the same amount of increase in T.