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Sovereign spreads and the effects of fiscal austerity

Diego Anzoategui

Journal of International Economics, 2022, vol. 139, issue C

Abstract: 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)
Date: 2022
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DOI: 10.1016/j.jinteco.2022.103658

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