DP9383 Spending-based austerity measures and their effects on output and unemployment

Author(s): Dimitrios Bermperoglu, Evi Pappa, Eugenia Vella
Publication Date: March 2013
Keyword(s): austerity, NK model, output and unemployment multipliers, search and matching frictions, sign restrictions, VARs
JEL(s): C11, E12, E32, E62
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9383

We compare the output and unemployment effects of fiscal adjustments in different types of government outlays in the US, Canada, Japan, and the UK. We identify shocks in government consumption, investment, vacancies and government wages in a SVAR using sign restrictions extracted from a New-Keynesian model with matching frictions in the private and public sector, endogenous labor force participation and heterogeneous unemployed jobseekers. Government vacancy cuts are associated with the highest output losses and the lowest gains in terms of deficit reductions. This is because such shocks generate an additional wealth effect: they induce a fall in the number of working members of the household that leads to a fall in private consumption and investment demand. On the other hand, government wage cuts are the least destructive device for cutting the budget.