Why Austerity Can Be Self-Defeating for Member States of a Currency Union

Abstract

Despite all efforts to reduce government budget deficits, debt-to-GDP ratios of crisis-hit member states of the European Monetary Union are still growing faster than expected. At the same time GDP growth performance is poor and according to most forecasts expected to worsen. In this paper I show, based on a formal analysis of the determinants of debt-to-GDP ratios, that this is the likely outcome of austerity policy in member states of a currency union with overindebted private sectors.

Keywords: Fical Policy, Austerity Debate, Currency Union

JEL Classification: E62