No two countries took the same path to recovery following the 2009 Great Recession. In “Austerity in the Aftermath of the Great Recession,” Christopher L. House (U-M), Christian Proebsting (PhD '16, École Polytechnique Fédérale de Lausanne), and Linda L. Tesar (U-M) seek to find out if the examination of fiscal austerity can clarify the diversity of experiences felt by advanced economies.
The authors use a multi-country DSGE model featuring government purchases shocks, monetary shocks, and shocks to financial markets to see if standard macroeconomic theory can explain observed changes in economic activity. This model allows for direct comparisons between the observed empirical relationships in data and model predictions.
The model successfully reproduces a large cross-sectional multiplier of government austerity shocks on output that broadly matches patterns observed in the data.
The authors found that austerity was a substantial drag on GDP and that had countries in the euro area refrained from negative fiscal shocks, they may have had lower debt-to-GDP ratios across European nations due to substantially higher output.
We examine austerity in advanced economies since the Great Recession. Austerity shocks are reductions in government purchases that exceed reduced-form forecasts. Austerity shocks are statistically associated with lower real GDP, lower inflation and higher net exports. We estimate a cross-sectional multiplier of roughly 2. A multi-country DSGE model calibrated to 29 advanced economies generates a multiplier consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity shocks were sufficiently contractionary that debt-to-GDP ratios in some European countries increased as a consequence of endogenous reductions in GDP and tax revenue.