Working Paper: CEPR ID: DP10425
Authors: Benjamin Born; Gernot Müller; Johannes Pfeifer
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 Codes: C32; E43; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial conditions poor (P17) | long-term decline in default premia (G33) |
| austerity measures during fiscal stress (E62) | sovereign default premium (H63) |
| austerity measures (E65) | long-term sovereign default premium (H63) |
| austerity measures (E65) | sovereign default premium (H63) |
| austerity measures (E65) | output (C67) |
| austerity measures during benign economic conditions (E65) | sovereign default premium (H63) |
| austerity measures (E65) | short-run output (E23) |