The Austerity Threshold

Vadim Elenev, Tim Landvoigt and Stijn Van Nieuwerburgh

No 34397, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce a new indicator of fiscal capacity—the “austerity threshold”: the debt-to-GDP level above which the government must raise fiscal surpluses to ensure debt safety. In a model with realistic risk premia, nominal rigidities, and an intermediary sector, calibrated to the U.S., we estimate this threshold at 189%. We highlight the roles of safety premia and intermediation-driven convenience yields. The threshold varies with the source of surpluses: spending cuts reduce inflation and allow low interest rates, while tax increases distort labor supply and raise inflation. Uncertainty over the austerity regime—spending cuts or tax increases—sharply lowers fiscal capacity. The expected austerity regime affects asset prices and macro outcomes even when debt-to-GDP is well below the threshold.

JEL-codes: E10 E40 E60 G12 G18 G2 (search for similar items in EconPapers)
Date: 2025-10
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