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May austerity be counterproductive?

Author

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  • Pablo García Sánchez
  • Miguel Sebastián

    (Universidad Complutense de Madrid)

Abstract

This paper investigates the impact that fiscal policy has on economic activity and sovereign debt during economic downturns in the euro area, mainly Germany and Spain. Our theoretical and empirical framework shows that the macroeconomic returns of austerity crucially depend on the values of fiscal multipliers. We find that, for the Spanish economy, even if policy makers just focus on the public debt ratio, ignoring output and unemployment, policies of deficit reduction may be self-defeating, especially if carried on via tax increases. In fact, counter cyclical policies beat deficit consolidation policies in stabilizing the sovereign debt ratio, no matter if shocks are on aggregate supply or aggregate demand. By contrast, in the German case, we cannot reject the hypothesis that austerity works, even under a sluggish economy.

Suggested Citation

  • Pablo García Sánchez & Miguel Sebastián, 2013. "May austerity be counterproductive?," Working Papers 13-07, Asociación Española de Economía y Finanzas Internacionales.
    • Handle: RePEc:aee:wpaper:1307
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    References listed on IDEAS

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    1. Pablo Burriel & Francisco de Castro & Daniel Garrote & Esther Gordo & Joan Paredes & Javier J. Pérez, 2010. "Fiscal Policy Shocks in the Euro Area and the US: An Empirical Assessment," Fiscal Studies, Institute for Fiscal Studies, vol. 31(2), pages 251-285, June.
    2. Ansgar Belke & Jens Klose, 2009. "Does the ECB Rely on a Taylor Rule?: Comparing Ex-post with Real Time Data," Discussion Papers of DIW Berlin 917, DIW Berlin, German Institute for Economic Research.
    3. Jean Imbs & Isabelle Mejean, 2010. "Trade Elasticities: A Final Report for the European Commission," European Economy - Economic Papers 2008 - 2015 432, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    4. Ansgar Belke & Jens Klose, 2011. "Does the ECB Rely on a Taylor Rule During the Financial Crisis? Comparing Ex-post and Real Time Data with Real Time Forecasts," Economic Analysis and Policy, Elsevier, vol. 41(2), pages 147-171, September.
    5. Jocelyn Boussard & Francisco de Castro & Matteo Salto, 2012. "Fiscal Multipliers and Public Debt Dynamics in Consolidations," European Economy - Economic Papers 2008 - 2015 460, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
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    Cited by:

    1. Carmen Díaz-Roldán, 2017. "Fiscal Performance in Monetary Unions: How Much Austerity Should Be Allowed?," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 64(1), pages 61-76, December.

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    More about this item

    Keywords

    Sovereign Debt; Fiscal Policy; Fiscal Multipliers;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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