DP14072 Austerity and Public debt Dynamics

Author(s): Carlo A. Favero, Pierfrancesco Mei
Publication Date: October 2019
Keyword(s): austerity, fiscal adjustment plans, output growth, public debt
JEL(s): E60, E62
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14072

This paper studies the impact of multi-year fiscal consolidation plans on public debt dynamics. Studying the dynamic impact of narratively identified fiscal adjustment plans we find that tax based adjustments result in significant slowdowns of output and inflation but have almost no effect on the debt GDP ratio over a short to medium-term horizon. Spending cuts have instead milder recessionary effects, but contribute to a sustained reduction in the debt GDP ratio. Extending our model to study non-linearities in the dynamics related to the business-cycle and the public debt to GDP ratio, we find that the heterogeneous impact of tax-based and expenditure-based plans on debt mainly emerges mostly in recessions and when debt is increasing rapidly.