By Christopher House, Christian Proebsting and Linda Tesar
Cross-country differences in austerity, defined as government purchases below forecast, account for 75 percent of the observed cross-sectional variation in GDP in advanced economies during 2010-2014. Statistically, austerity is associated with lower GDP, lower inflation and higher net exports. A multi-country DSGE model calibrated to 29 advanced economies generates effects of austerity consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity was so contractionary that debt-to-GDP ratios in some countries increased as a result of endogenous reductions in GDP and tax revenue.
Beyond the very relevant topic, this paper is a nice demonstration that fiscal policy is not a simple accounting exercise: the economy in its entirely is an endogenous object that responds to policy, sometimes in strong ways (like the increase in the debt/GDP ratio mentioned in the abstract).