Austerity in the Aftermath of the Great Recession

Source: Christopher L. House, Christian Proebsting, Linda L. Tesar, National Bureau of Economic Research, NBER Working Paper No. 23147, February 2017
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We examine austerity in advanced economies since the Great Recession. Austerity shocks are reductions in government purchases that exceed reduced-form forecasts. Austerity shocks are statistically associated with lower real GDP, lower inflation and higher net exports. We estimate a cross-sectional multiplier of roughly 2. A multi-country DSGE model calibrated to 29 advanced economies generates a multiplier consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity shocks were sufficiently contractionary that debt-to-GDP ratios in some European countries increased as a consequence of endogenous reductions in GDP and tax revenue.