Self-defeating austerity at the zero lower bound

Richard McManus, Gulcin Ozkan and Dawid Trzeciakiewicz

Discussion Papers from Department of Economics, University of York

Abstract: Fiscal consolidation programmes have been adopted almost uni-versally in the developed world since 2011 in an effort to reverse the substantially worsened fiscal outlook in the aftermath of the global financial crisis. Prolonged stagnation combined with increasing debt levels over this period led many to question whether fiscal austerity can be self-defeating. This paper attempts to answer this question by presenting a comprehensive examination of fiscal policy when the nom-inal interest rates are at the zero lower bound (ZLB). In doing so, we propose an alternative measure of fiscal policy effectiveness in the form of bond multipliers that are based on the evolution of debt to GDP ratios. We show that, in contrast to the normal times, when interest rates are at their ZLB paths of government debt arising from different fiscal instruments could be very different, leading to self-defeating austerity in certain combinations of fiscal adjustment programs. Our findings, therefore suggest that self-defeating austerity, while a likely outcome with some instruments, can be avoided by judicious choice of the composition of fiscal action.

Keywords: fiscal austerity; zero lower bound; composition of fiscal adjustment (search for similar items in EconPapers)
JEL-codes: E65 H2 H3 (search for similar items in EconPapers)
Date: 2014-10
New Economics Papers: this item is included in nep-mac and nep-pbe
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Citations: View citations in EconPapers (6)

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