Sovereign spreads and the effects of fiscal austerity
Journal of International Economics, 2022, vol. 139, issue C
I analyze the impact of austerity on sovereign spreads. To do so I propose a model with strategic sovereign default and nominal rigidities, where the government follows fiscal rules, which are estimated from data. I first study theoretical implications and find that austerity can increase sovereign spreads, or be self-defeating, only when the decrease in government spending is persistent and the economy is expected to be in a recession with high fiscal multipliers. I then calibrate the model and use it to predict what would have happened to spreads and economic activity if Spain had continued to follow its pre-2010 fiscal rule instead of switching to the austerity track. I find that, relative to the counter-factual, austerity decreased sovereign spreads and debt-to-GDP ratios. Overall, I find that the likelihood of self-defeating austerities depends on the magnitude of fiscal multipliers and fiscal policy, but it is generally low.
Keywords: Sovereign default; Fiscal austerity (search for similar items in EconPapers)
JEL-codes: E62 F34 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:139:y:2022:i:c:s0022199622000903
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