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May austerity be counterproductive?

Pablo García Sánchez () and Miguel Sebastián ()
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Miguel Sebastián: Universidad Complutense de Madrid

No 13-07, Working Papers from Asociación Española de Economía y Finanzas Internacionales

Abstract: This paper investigates the impact that fiscal policy has on economic activity and sovereign debt during economic downturns in the euro area, mainly Germany and Spain. Our theoretical and empirical framework shows that the macroeconomic returns of austerity crucially depend on the values of fiscal multipliers. We find that, for the Spanish economy, even if policy makers just focus on the public debt ratio, ignoring output and unemployment, policies of deficit reduction may be self-defeating, especially if carried on via tax increases. In fact, counter cyclical policies beat deficit consolidation policies in stabilizing the sovereign debt ratio, no matter if shocks are on aggregate supply or aggregate demand. By contrast, in the German case, we cannot reject the hypothesis that austerity works, even under a sluggish economy.

Keywords: Sovereign Debt; Fiscal Policy; Fiscal Multipliers (search for similar items in EconPapers)
JEL-codes: E62 H30 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-mac and nep-pbe
Date: 2013-10
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