The "Austerity Myth": Gain Without Pain?
As governments around the world contemplate slashing budget deficits, the "expansionary fiscal consolidation hypothesis" is back in vogue. I argue that, as a statement about the short run, it should be taken with caution. I present four detailed case studies, two - Denmark and Ireland - undertaken under fixed exchange rates (the most relevant case for many Eurozone countries today) and two - Finland and Sweden - after floating the currency.
All four episodes were associated with an expansion; but only in Denmark the driver of growth was internal demand. However, after three years a long slump set in as the economy lost competitiveness. In all the others for a long time the main driver of growth was exports. In Ireland this occurred because the sterling coincidentally appreciated. In Finland and Sweden the currency experienced an extremely large depreciation after floating.
In all consolidations interest rate fell fast, and wage moderation played a key role in generating a gain competitiveness and a decline in interest rates. These results cast doubt on at least some versions of the "expansionary fiscal consolidations" hypothesis.
This paper was produced as part of the project Growth and Sustainability Policies for Europe (GRASP), a Collaborative Project funded by the European Commission's Seventh Research Framework Programme, contract number 244725. Financial support by the European Research Council (Grant No. 230088) is also gratefully acknowledged. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.