Does Austerity Pay Off?

58 Pages Posted: 17 Feb 2015

See all articles by Benjamin Born

Benjamin Born

Frankfurt School of Finance & Management gemeinnützige GmbH

Gernot J. Müller

University of Tuebingen - Department of Economics

Johannes Pfeifer

University of Mannheim - School of Economics (VWL)

Date Written: February 2015

Abstract

We ask whether cuts of government consumption lower or raise the sovereign default premium. To address this question, we set up a new data set for 38 emerging and advanced economies which contains quarterly time-series observations for sovereign default premia, government consumption, and output. We find that whether austerity pays off depends on a) initial conditions and b) the time-horizon under consideration. Spending cuts in times of fiscal stress raise default premia, but lower premia in benign times. These findings pertain to the short run. Austerity always pays off in the long run, but particularly so if initial conditions are bad.

Keywords: austerity, default premium, fiscal policy, fiscal stress, local projections, panel VAR, sovereign risk

JEL Classification: C32, E43, E62

Suggested Citation

Born, Benjamin and Müller, Gernot J. and Pfeifer, Johannes, Does Austerity Pay Off? (February 2015). CEPR Discussion Paper No. DP10425, Available at SSRN: https://ssrn.com/abstract=2566328

Benjamin Born (Contact Author)

Frankfurt School of Finance & Management gemeinnützige GmbH ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Johannes Pfeifer

University of Mannheim - School of Economics (VWL) ( email )

Mannheim 68131
Germany

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