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Expansionary Austerity and Reverse Causality

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  • Breuer, Christian

Abstract

Empirical studies on the effects of fiscal policy using the conventional or data-based approach and the Blanchard-method of cyclical adjustment or the Blanchard Fiscal Impulse (BFI) discovered that fiscal consolidations can be expansionary, particularly in the case of spending-cuts. In this paper, it is stated this finding is affected by reverse causality, i.e. increasing GDP causally decreases expenditure-GDP-ratios if the cyclical adjustment strategy fails to correct for cyclical effects. It is also illustrated that the BFI as used in the literature does not appropriately control for cyclical effects in the case of expenditure-GDP-ratios and the resulting BFI is endogenously correlated with the economic cycle. This might explain why previous studies based on the BFI pointed to counter-intuitive findings when examining cuts in government expenditure. Replicating one prominent example of literature on expansionary austerity and comparing both the results based on the BFI and the results based on standard cyclical adjustment strategies, only the BFI-based results show expansionary effects of fiscal consolidations, while these effects disappear after applying standard methods of cyclical adjustment.

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  • Breuer, Christian, 2017. "Expansionary Austerity and Reverse Causality," MPRA Paper 77556, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:77556
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    Cited by:

    1. Christian Breuer & Chang Woon Nam, 2020. "Fiscal Consolidation and the Current Account: OECD Evidence," CESifo Working Paper Series 8071, CESifo.
    2. Bardaka, Ioanna & Bournakis, Ioannis & Kaplanoglou, Georgia, 2021. "Total factor productivity (TFP) and fiscal consolidation: How harmful is austerity?," Economic Modelling, Elsevier, vol. 94(C), pages 908-922.
    3. Richard Kozul-Wright, 2020. "Recovering Better from COVID-19 Will Need a Rethink of Multilateralism," Development, Palgrave Macmillan;Society for International Deveopment, vol. 63(2), pages 157-161, December.
    4. Thibault Lemaire, 2020. "Fiscal Consolidations and Informality in Latin America and the Caribbean," Post-Print halshs-02492309, HAL.
    5. Gianni Vaggi & Luca Frigerio, 2021. "Foreign debt sustainability and human development in Sub Saharan Africa," DEM Working Papers Series 203, University of Pavia, Department of Economics and Management.

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    More about this item

    Keywords

    fiscal policy; fiscal adjustment; cyclical adjustment; reverse causality;
    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
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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