Austerity

Harris Dellas () and Dirk Niepelt

No 78, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: We shed light on the function, properties and optimal size of austerity using the standard sovereign model augmented to include incomplete information about credit risk. Austerity is defined as the shortfall of consumption from the level desired by a country and supported by its repayment capacity. We find that austerity serves as a tool for securing a more favorable loan package; that it is associated with over-investment even when investment does not create collateral; and that low risk borrowers may favor more to less severe austerity. These findings imply that the amount of fresh funds obtained by a sovereign is not a reliable measure of austerity suffered; and that austerity may actually be associated with higher growth. Our analysis accommodates costly signalling for gaining credibility and also assigns a novel role to spending multipliers in the determination of optimal austerity.

Keywords: austerity; credit rationing; default; growth; incomplete information; investment; pooling equilibrium; separating equilibrium (search for similar items in EconPapers)
JEL-codes: F34 H63 (search for similar items in EconPapers)
Date: 2014
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https://www.econstor.eu/bitstream/10419/106146/1/81540896X.pdf (application/pdf)

Related works:
Journal Article: Austerity (2021)
Working Paper: Austerity (2014)
Working Paper: Austerity (2014)
Working Paper: Austerity (2014)
Working Paper: Austerity (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:78

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