Austerity, fiscal uncertainty, and economic growth: Insights from fiscally weak EU countries

Giuliano Curatola, Michael Donadelli, Alessandro Gioffré and Patrick Grüning

No 56, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: Recent empirical evidence suggests that during the last years fiscally weak European countries significantly cut their R&D budgets in an effort to reduce their deficit, according to the spirit of the Fiscal Compact. We propose a general equilibrium model that endogenously captures the trade-off between costs and benefits of austerity measures driven by a zero-deficit policy. Our analysis suggests that cuts in R&D spending undermine economic growth both in the short and the long run. We use our model to estimate the reduction of economic growth due to R&D cuts implemented by fiscally weak European countries during the period 2010-2012. The model predicts a reduction in real growth by 0:63%, 2:93%, and 4:46%, in the next 1, 5, and 10 years, respectively. Moreover, we show that the zero-deficit constraint hampers economic growth in the presence of either a productivity drop or a spending stimulus.

Keywords: Austerity Measures; Fiscal Policy; Endogenous Growth; R&D (search for similar items in EconPapers)
JEL-codes: E21 E23 E62 G18 (search for similar items in EconPapers)
Date: 2015, Revised 2015
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-gro and nep-ino
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:56

DOI: 10.2139/ssrn.2458855

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