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Does Austerity Pay Off?
Benjamin Born (U Bonn, CEPR, CESifo)
Gernot J. M¨uller (U T¨ubingen, CEPR, CESifo)
Johannes Pfeifer (U Cologne)
ADEMU Workshop on “Fiscal Risk
and Public Sector Balance Sheets”, Bonn, July 2017
Spending cuts and sovereign default premia
Euro area 2010Q1–2012Q2
0 2 4 6 8 10 12 14
Reduction of government consumption (percent)
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2200
Changeofdefaultpremium(basispoints)
Austria
Belgium
Finland
France
Germany
Greece
IrelandItaly
Netherlands
Portugal
Slovakia
Slovenia
Spain
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 1/20
Does austerity pay off?
Does austerity cause the sovereign default premium to decline?
And, if so, when and under which circumstances?
Default premium: market-based assessment of debt sustainability,
reflecting
Fiscal fundamentals/capacity, often not directly observed
(Arellano, 2008; Bi, 2012)
Market sentiment (Calvo, 1988; Cole and Kehoe, 2000;
De Grauwe and Ji, 2012; Roch and Uhlig, 2015)
Financing costs
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 2/20
Three contributions
1. New panel-data set for 38 emerging and developed economies
Sovereign default premium
Exhaustive government consumption
2. Estimate effect of government consumption on default premium
State of public finances: fiscal stress vs. benign times
Size of fiscal measure: in particular spending cut vs. increase
Time horizon: short vs. long run
3. Rationalize results in structural model of sovereign default
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 3/20
Literature
Recent work on spreads
Longstaff et al. (2011), Borri and Verdelhan (2011), Broner,
Lorenzoni, and Schmukler (2013), Bernoth, von Hagen, and
Schuknecht (2012). . .
Classic studies of consolidation episodes and narrative approaches
Giavazzi and Pagano (1990), Alesina and Perotti (1995),
Ramey and Shapiro (1998), Devries et al. (2011), Jord´a and
Taylor (2013), Beetsma, Furtuna, and Giuliodori (2016) . . .
State dependence
Perotti (1999), Christiano, Eichenbaum, and Rebelo (2011),
Auerbach and Gorodnichenko (2012), Corsetti et al. (2013),
Ilzetzki, Mendoza, and V´egh (2013), Ramey and Zubairy
(2014) . . .
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 4/20
New data set covering 38 countries (1991Q1–2014Q2)
Three time series for emerging and developed economies (baseline)
Government consumption (Ilzetzki et al, 2013)
GDP
Sovereign default premium
Default premium: sovereign yield vis-`a-vis riskless reference
country, measured in common currency
Emerging markets: J.P. Morgan EMBI spreads
Euro area: long-term interest rate for convergence purposes
European countries’ foreign-currency government bonds
CDS spreads available at end of sample for some countries
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 5/20
Identify fiscal shocks in smooth-transition VAR
Vector of endogenous variables
Xi,t = log(gi,t), log(yi,t), ∆si,t
Identification (Blanchard and Perotti, 2002)
Within quarter, government consumption predetermined
Smooth-transition VAR (Auerbach and Gorodnichenko, 2012)
Xi,t = F(zi,t)ΛA(L)Xi,t−1 + [1 − F(zi,t)] ΛB(L)Xi,t−1 + νi,t
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 6/20
Weighting function: cdf of actual default premium
0 5 10 15 20
Default premium (pps)
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Cumulativedensity
Full Sample
Developed
Emerging
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 7/20
Results for VAR
Estimate effect of a cut of government consumption
Unbalanced panel for 38 countries, 1991Q1 to 2014Q2
(≈ 2300 observations)
Include country-specific constant/trend and time-fixed effects
Weighting function country-group specific
Impulse responses to cut of government consumption by 1 percent
Cumulative response of default premium ∆si,t, as well as
response of government consumption and output
Bootstrapped 90%-confidence bounds
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 8/20
Response to fiscal shock depends on fiscal stress
Government consumption
0 5 10 15 20
-1
-0.8
-0.6
-0.4
-0.2
0
GDP
0 5 10 15 20
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 5 10 15 20
-10
-5
0
5
10
(a) Unconditional VAR
Government consumption
0 5 10 15 20
-1
-0.8
-0.6
-0.4
-0.2
0
Stress
No stress
GDP
0 5 10 15 20
-0.4
-0.3
-0.2
-0.1
0
0.1
Default premium (basis points)
0 5 10 15 20
-20
-15
-10
-5
0
5
(b) Conditional: fiscal stress vs. no stress
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 9/20
Austerity pays off, but only in the long run
Government consumption
0 20 40 60 80
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
Stress
No stress
GDP
0 20 40 60 80
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 20 40 60 80
-30
-20
-10
0
10
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 10/20
Zoom in on short-run dynamics: further evidence on
response of default premium (based on local projections)
Gov. consumption cut (symmetric model)
0 1 2 3 4 5
-50
0
50
100
No Stress
Stress
Large Shock
Gov. consumption cut
0 1 2 3 4 5
-50
0
50
100
Gov. consumption hike
0 1 2 3 4 5
-50
0
50
100
Size of shock matters too (large: shock is > 2SE)
Premium rises disproportially in response to large cuts
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 11/20
Results are robust. . .
Additional control variables Figure
Excluding Great Recession Figure
Number of sample splits (e.g. advanced vs. emerging) Figure
Conservative data quality sample Figure
Including stock market indices Figure
Confidence Figure
Cross-sectional heterogeneity: mean-group estimator Figure
Monetary union/dollarization vs. own legal tender Figure
Excluding IMF program countries Figure
Boom vs. recession Figure
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 12/20
Concern 1: Reverse causality
Main finding
Cutting government consumption raises default premium in
short run, if fiscal stress high
Co-movement caused by premium? Ruled out under our
identification scheme...
Support for assumption that gov. consumption is predetermined
Isolate common factor of default premium in cross section of
panel (principal component)
Project country-specific variables on common factor
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 13/20
Response to common factor of sovereign default premium
Government consumption reacts with delay only
Government consumption
0 1 2 3 4 5 6 7 8
-3
-2
-1
0
1
2
3
×10
-3
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-4
-3
-2
-1
0
1
×10
-3
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-20
0
20
40
60
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 14/20
Concern 2: Fiscal foresight
Fiscal policy innovations possibly anticipated (Leeper, Walker, and
Yang, 2012; Ramey, 2011)
Information sets of econometrician and agents not aligned
Structural shocks not recoverable from observables:
“nonfundamentalness” (Lippi and Reichlin, 1994)
Local projection
Replace government consumption with forecast error compiled
by OECD
Available for subsample of OECD countries (semi-annual
observations)
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 15/20
Response of premium to government consumption
Anticipation effects—if anything—seem to dampen spread response
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-40
-20
0
20
40
No Stress
Stress
(a) Forecast error
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-30
-20
-10
0
10
20
30
(b) Actual consumption
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 16/20
Zoom in on short-run dynamics: theory
Robust—and (perhaps) surprising—feature of data
Cutting government consumption raises default premium in
short run, if fiscal stress high
Structural model of sovereign default
Minimal departure from workhorse model of Arellano (2008)
Exogenous variation of government consumption and
multiplier effect of 0.7
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 17/20
Model simulation: response of default premium
2 4 6 8
-50
-25
0
25
50
DefaultPremium(basispoints)
Government consumption hike (1 SE)
No stress
Stress
2 4 6 8
-50
-25
0
25
50
Government consumption cut (1 SE)
2 4 6 8
-50
-25
0
25
50
Government consumption cut (3 SE)
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 18/20
Model: pricing of default risk actuarially fair
International investors risk neutral, demand premium according to
(prob. of default: δt)
1 + rt =
1 + r
1 − δt
Higher premium reflects higher prob. of default
Lower government consumption reduces output
Resource costs of default decline (Arellano, 2008)
Incentives to default increase temporarily
Effect non-linear
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 19/20
Conclusion
Does austerity pay off?
Yes, but only in the long run: default premium declines in
response to spending cut after about 1-2 years
Short run (& fiscal stress): output declines and premium rises
Markets not “schizophrenic” about austerity (Blanchard, 2011)
Output loss makes default more likely in short run: default
premium rises
Premium falls, as output recovers
Naive observer may conclude that “austerity is not working”
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 20/20
Local projections
Jord´a (2005), Granger and Ter¨asvirta (1993), Auerbach and Gorodnichenko (2013)
Impulse response to government-consumption shock
xi,t+h =F (zi,t) ψA,hεg
i,t + [1 − F (zi,t)] ψB,hεg
i,t + ui,t+h
Consider first equation of VAR model (under Blanchard-Perotti)
gi,t = F (zi,t) ΓA(L)Xi,t−1 + [1 − F (zi,t)] ΓB(L)Xi,t−1 + εg
i,t
Combining (and adding deterministics) yields local projection
xi,t+h = αi,h + βi,ht + ηt,h
+ F (zi,t) ψA,h gi,t + [1 − F (zi,t)] ψB,h gi,t
+ squares and cross terms of lags
+ ui,t+h
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 21/20
Impulse response functions
Response in period t + h, conditional on experiencing state indexed
by zi,t:
∂xt+h
∂εg
i,t zi,t
= F (zi,t) ψA,h + [1 − F (zi,t)] ψB,h
Measures average response of economy in state zi,t going
forward
Conditional linearity allows using Wald-type test for assessing
significance of different responses
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 22/20
Results for local projections
Estimate effect of a cut of government consumption
Unbalanced panel for 38 countries (≈ 2300 observations)
Include country-specific constant/trend and time-fixed effects
Weighting function country-group specific
Impulse responses to cut of government consumption by 1 percent
Estimate panel model for horizon of up to 8 quarters; less
reliable for longer horizons (Ramey, 2012)
Confidence bounds based on Driscoll and Kraay (1998)
standard errors: robust to heteroskedasticity, serial, and
cross-sectional correlation
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 23/20
Response to fiscal shock depends on fiscal stress
Government consumption
0 1 2 3 4 5 6 7 8
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
GDP
0 1 2 3 4 5 6 7 8
-0.2
-0.15
-0.1
-0.05
0
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-2
0
2
4
6
(a) Unconditional LP
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
(b) Conditional: fiscal stress vs. no stress times
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 24/20
Spending cuts vs. increases and small vs. large
Include positive and negative structural shocks separately
xi,t+h = F (zi,t) ψ−
A,h ˆεg−
i,t + [1 − F (zi,t)] ψ−
B,h ˆεg−
i,t
+ F (zi,t) ψ+
A,h ˆεg+
i,t + [1 − F (zi,t)] ψ+
B,h ˆεg+
i,t
+ . . . + ui,t
Allow for different effect of large shocks (cuts and hikes)
xi,t+h = F (zi,t) ψA,h ˆεg
i,t + [1 − F (zi,t)] ψB,h ˆεg
i,t
+ F (zi,t) ψbig
A,h ˆεg
i,t1>2SE + [1 − F (zi,t)] ψbig
B,h ˆεg
i,t1>2SE
+ . . . + ui,t
Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 25/20
Exhaustive government consumption
Refers to a national accounting concept: goods
purchased/produced by the government for final consumption
→ mostly wages, goods and services purchases, and benefits
in kind while excluding monetary transfers
By definition includes “social transfers in kind related to
expenditure on products supplied to households via market
producers” (different from US)
Different than “government expenditure” which often denotes
all cash outlays by the government
Should be accrual-based, not cash-based
Excludes government investment
Still based on SNA95 (next revision will use SNA2010 where
available)
Relates to general or central government depending on the
country
back
Appendix References 26/20
Construction of default premium: two examples
Italy
1990 1995 2000 2005 2010
0
2
4
6
8
10
Spread
Yield
Benchmark
United Kingdom
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
0
2
4
6
8
B1
B1 B1+B2 Long Term Convergence Rates
B2 CMA
CDS
TR
CDS
B2
Appendix References 27/20
Gov. consumption: quarterly data for 38 countries
Country first obs last obs min max mean std
Argentina 1994Q1 2013Q3 0.12 0.18 0.14 0.02
Australia 2003Q2 2010Q3 0.17 0.18 0.17 0.00
Austria 1994Q1 2014Q1 0.18 0.21 0.19 0.01
Belgium 1995Q1 2014Q1 0.21 0.25 0.23 0.01
Brazil 1995Q1 2014Q1 0.19 0.23 0.20 0.01
Bulgaria 1999Q1 2014Q1 0.14 0.20 0.18 0.02
Chile 1999Q3 2014Q2 0.05 0.06 0.06 0.00
Colombia 2000Q1 2014Q1 0.15 0.17 0.16 0.01
Croatia 2004Q2 2014Q1 0.18 0.21 0.20 0.01
Czech Republic 2004Q2 2014Q1 0.19 0.22 0.21 0.01
Denmark 1991Q1 2014Q1 0.25 0.30 0.26 0.01
Ecuador 1995Q2 2014Q1 0.09 0.14 0.12 0.02
El Salvador 2002Q3 2014Q1 0.06 0.09 0.07 0.01
Finland 1992Q3 2014Q1 0.20 0.25 0.22 0.02
France 1999Q2 2014Q1 0.23 0.25 0.24 0.01
Germany 2004Q2 2014Q1 0.18 0.20 0.19 0.01
Greece 2000Q1 2011Q1 0.17 0.22 0.18 0.01
Hungary 1999Q2 2014Q1 0.20 0.25 0.22 0.01
Ireland 1997Q1 2014Q1 0.14 0.21 0.17 0.02
Appendix References 28/20
Gov. consumption: quarterly data for 38 countries cont’d
Country first obs last obs min max mean std
Italy 1991Q1 2014Q1 0.17 0.22 0.19 0.01
Latvia 2006Q2 2014Q1 0.15 0.22 0.18 0.02
Lithuania 2005Q3 2014Q1 0.17 0.22 0.19 0.02
Malaysia 2000Q1 2014Q1 0.07 0.12 0.10 0.01
Mexico 1994Q1 2014Q2 0.00 0.00 0.00 0.00
Netherlands 1999Q2 2014Q2 0.20 0.27 0.24 0.02
Peru 1997Q2 2014Q2 0.07 0.09 0.08 0.01
Poland 1995Q1 2014Q1 0.17 0.20 0.18 0.01
Portugal 1995Q1 2014Q1 0.17 0.22 0.19 0.01
Slovakia 2004Q2 2014Q1 0.17 0.20 0.18 0.01
Slovenia 2003Q2 2014Q1 0.17 0.21 0.19 0.01
South Africa 1995Q1 2014Q1 0.18 0.23 0.20 0.01
Spain 1995Q1 2014Q1 0.17 0.22 0.19 0.02
Sweden 1993Q2 2014Q2 0.07 0.10 0.08 0.01
Thailand 1997Q3 2014Q2 0.10 0.14 0.12 0.01
Turkey 1998Q1 2014Q1 0.10 0.16 0.13 0.01
United Kingdom 1993Q1 2013Q4 0.17 0.23 0.20 0.02
United States 2008Q1 2014Q1 0.15 0.17 0.16 0.01
Uruguay 2001Q3 2014Q1 0.10 0.14 0.11 0.01
Appendix References 29/20
Example: weighting functions for Italy
Note: fiscal stress = recessions
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Fiscal Stress
Recession
Appendix References 30/20
Local projections to establish robustness of results for the
short-run
Additional controls: gross public debt
GDP
0 1 2 3 4 5 6 7 8
-0.3
-0.2
-0.1
0
0.1
0.2
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-40
-20
0
20
40
Debt/GDP (percentage points)
0 1 2 3 4 5 6 7 8
-1
-0.5
0
0.5
1
Debt only available for smaller sample
Debt-to-GDP ratio rises during stress
back
Appendix References 31/20
The response of confidence to a government spending
shock
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Confidence
0 1 2 3 4 5 6 7 8
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
Confidence (Ifo WES) pertains to expectations regarding
economic conditions in the next 6 months.
Fiscal stress: confidence is unresponsive to the spending cut
No stress times: confidence tends to improve a year after
spending cut
→ austerity less harmful whenever it improves confidence
back
Appendix References 32/20
Including national stock market indices
GDP
0 1 2 3 4 5 6 7 8
-0.3
-0.2
-0.1
0
0.1
0.2
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Stock market index
0 1 2 3 4 5 6 7 8
-1
-0.5
0
0.5
1
back
Appendix References 33/20
Boom vs. recession
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
Boom
Recession
GDP
0 1 2 3 4 5 6 7 8
-0.3
-0.2
-0.1
0
0.1
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Similar to fiscal stress vs. no stress times
But: overlap between episodes is far from perfect
back
Appendix References 34/20
Austerity does not pay off in times of fiscal stress (top),
pre financial crisis sample (bottom)
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
back
Appendix References 35/20
Advanced (top) vs. emerging (bottom)
Government consumption
0 1 2 3 4 5 6 7 8
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-60
-40
-20
0
20
40
60
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.2
0
0.2
0.4
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-5
0
5
10
back
Appendix References 36/20
Euro area: crisis (top) vs. non-crisis countries (bottom)
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
1
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.5
0
0.5
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-80
-60
-40
-20
0
20
40
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-1
-0.5
0
0.5
1
1.5
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
20
back
Appendix References 37/20
Full sample (top) vs. conservative sample (bottom)
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
15
Appendix References 38/20
Cross-sectional heterogeneity: mean-group estimator
Government spending
0 1 2 3 4 5 6 7 8
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
Baseline model
Mean group estimator
GDP
0 1 2 3 4 5 6 7 8
-0.25
-0.2
-0.15
-0.1
-0.05
0
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
Take mean of coefficient of country-by-country regressions
Only possible for unconditional model
back
Appendix References 39/20
Monetary union/dollarization vs. own legal tender
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.6
-0.4
-0.2
0
0.2
0.4
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-60
-40
-20
0
20
40
60
(a) Monetary union or dollarization
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
-5
0
5
10
(b) Countries with their own legal tender
back
Appendix References 40/20
Transmission
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-50
0
50
Gov. net lending/GDP (percentage points)
0 1 2 3 4 5 6 7 8
-0.2
-0.1
0
0.1
0.2
(a) Including government net lending/GDP ratio
back
Appendix References 41/20
Transmission
GDP
0 1 2 3 4 5 6 7 8
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-10
0
10
20
30
Consumption
0 1 2 3 4 5 6 7 8
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
(a) Including private consumption
GDP
0 1 2 3 4 5 6 7 8
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
No Stress
Stress
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-20
-10
0
10
20
30
Investment
0 1 2 3 4 5 6 7 8
-3
-2
-1
0
1
(b) Including private investment
back
Appendix References 42/20
Excluding IMF program countries
Government consumption
0 1 2 3 4 5 6 7 8
-1.5
-1
-0.5
0
0.5
No Stress
Stress
GDP
0 1 2 3 4 5 6 7 8
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
Default premium (basis points)
0 1 2 3 4 5 6 7 8
-20
-10
0
10
20
30
back
Appendix References 43/20
Bibliography I
Alberto Alesina and Roberto Perotti. “Fiscal expansions and
adjustments in OECD countries”. In: Economic Policy 21.10
(1995), pp. 207–248.
Cristina Arellano. “Default risk and income fluctuations in
emerging economies”. In: American Economic Review 98
(2008), pp. 690–712.
Alan J. Auerbach and Yuriy Gorodnichenko. “Fiscal
multipliers in recession and expansion”. In: Fiscal Policy
after the Financial Crisis. Ed. by Alberto Alesina and
Francesco Giavazzi. Chicago: University of Chicago Press,
2013, pp. 63–98.
Alan J. Auerbach and Yuriy Gorodnichenko. “Measuring the
output responses to fiscal policy”. In: American Economic
Journal: Economic Policy 4.2 (May 2012), pp. 1–27.
Appendix References 44/20
Bibliography II
Roel Beetsma, Oana Furtuna, and Massimo Giuliodori. Does
the Confidence Fairy Exist? Evidence from a New Narrative
Dataset on Announcements of Fiscal Austerity Measures.
Tech. rep. 2016.
Kerstin Bernoth, J¨urgen von Hagen, and Ludger Schuknecht.
“Sovereign risk premiums in the European government bond
market”. In: Journal of International Money and Finance
31.5 (2012), pp. 975–995.
Huixin Bi. “Sovereign default risk premia, fiscal limits, and
fiscal policy”. In: European Economic Review 56 (2012),
pp. 389–410.
Appendix References 45/20
Bibliography III
Olivier J. Blanchard. “2011 In review: four hard truths”. In:
iMFdirect Blog. December 21, 2011, URL:
http://blog-imfdirect.imf.org/2011/12/21/2011-in-review-
four-hard-truths/.
2011.
Olivier J. Blanchard and Roberto Perotti. “An empirical
characterization of the dynamic effects of changes in
government spending and taxes on output”. In: Quarterly
Journal of Economics 117.4 (2002), pp. 1329–1368.
Nicola Borri and Adrien Verdelhan. Sovereign risk premia.
Tech. rep. 2011.
Fernando A. Broner, Guido Lorenzoni, and
Sergio L. Schmukler. “Why do emerging economies borrow
short term?” In: Journal of the European Economic
Association 11.S1 (2013), pp. 67–100.
Appendix References 46/20
Bibliography IV
Guillermo A. Calvo. “Servicing the public debt: the role of
expectations”. English. In: The American Economic Review
78.4 (1988), pp. 647–661.
Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo.
“When Is the government spending multiplier large?” In:
Journal of Political Economy 119.1 (2011), pp. 78 –121.
Harold L. Cole and Timothy J. Kehoe. “Self-Fulfilling Debt
Crises”. In: The Review of Economic Studies 67.1 (2000),
pp. 91–116.
Giancarlo Corsetti, Keith Kuester, Andr´e Meier, and
Gernot J. M¨uller. “Sovereign risk, fiscal policy, and
macroeconomic stability”. In: Economic Journal 123.566
(Feb. 2013), F99–F132.
Appendix References 47/20
Bibliography V
Paul De Grauwe and Yuemei Ji. “Mispricing of sovereign risk
and macroeconomic stability in the eurozone”. In: Journal
of Common Market Studies 50.6 (2012), pp. 866–880. doi:
10.1111/j.1468-5965.2012.02287.x.
Pete Devries, Jaime Guajardo, Daniel Leigh, and
Andrea Pescatori. A new action-based dataset of fiscal
consolidation. IMF Working Paper 11/128. 2011.
John C. Driscoll and Aart C. Kraay. “Consistent covariance
matrix estimation with spatially dependent panel data”. In:
The Review of Economics and Statistics 80.4 (Nov. 1998),
pp. 549–560.
Appendix References 48/20
Bibliography VI
Francesco Giavazzi and Marco Pagano. “Can severe fiscal
contractions be expansionary? Tales of two small European
countries”. In: NBER Macroeconomics Annual. Ed. by
Olivier J. Blanchard and Stanley Fischer. Vol. 5. Cambridge,
MA: MIT Press, Aug. 1990, pp. 75–122.
Clive W. J. Granger and Timo Ter¨asvirta. Modelling
nonlinear economic relationships. Oxford University Press,
1993.
Ethan Ilzetzki, Enrique G. Mendoza, and Carlos A. V´egh.
“How big (small?) are fiscal multipliers?” In: Journal of
Monetary Economics 60.2 (2013), pp. 239–254.
`Oscar Jord´a. “Estimation and inference of impulse responses
by local projections”. In: American Economic Review 95.1
(Mar. 2005), pp. 161–182.
Appendix References 49/20
Bibliography VII
`Oscar Jord´a and Alan M. Taylor. The time for austerity:
estimating the average treatment effect of fiscal policy.
NBER Working Papers 19414. 2013.
Eric M. Leeper, Todd B. Walker, and Shu-Chun Susan Yang.
Foresight and information flows. Tech. rep. 2012.
Marco Lippi and Lucrezia Reichlin. “VAR analysis,
non-fundamental representation, Blaschke matrices”. In:
Journal of Econometrics 63 (1994), pp. 307–325.
Francis A. Longstaff, Jun Pan, Lasse H. Pedersen, and
Kenneth J. Singleton. “How sovereign is sovereign credit
risk?” In: American Economic Journal: Macroeconomics 3.2
(2011), pp. 75–103.
Roberto Perotti. “Fiscal policy in good times and bad”. In:
Quarterly Journal of Economics 114.4 (Nov. 1999),
pp. 1399–1436.
Appendix References 50/20
Bibliography VIII
Valerie A. Ramey. “Comment on “Roads to Prosperity or
Bridges to Nowhere? Theory and Evidence on the Impact of
Public Infrastructure Investment””. In: NBER
Macroeconomics Annual 2012, Volume 27. NBER Chapters.
National Bureau of Economic Research, Inc, Sept. 2012,
pp. 147–153.
Valerie A. Ramey. “Identifying government spending shocks:
It’s all in the timing”. In: Quarterly Journal of Economics
126.1 (2011), pp. 1–50.
Valerie A. Ramey and Matthew D. Shapiro. “Costly capital
reallocation and the effects of government spending”. In:
Carnegie-Rochester Conference Series on Public Policy 48
(1998), pp. 145–198.
Appendix References 51/20
Bibliography IX
Valerie A. Ramey and Sarah Zubairy. Government spending
multipliers in good times and in bad: evidence from U.S.
historical data. NBER Working Paper 20719. Nov. 2014.
Francesco Roch and Harald Uhlig. The Dynamics of
Sovereign Debt Crises and Bailouts. Tech. rep. 2015.
Appendix References 52/20

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Does austerity pay off?

  • 1. Does Austerity Pay Off? Benjamin Born (U Bonn, CEPR, CESifo) Gernot J. M¨uller (U T¨ubingen, CEPR, CESifo) Johannes Pfeifer (U Cologne) ADEMU Workshop on “Fiscal Risk and Public Sector Balance Sheets”, Bonn, July 2017
  • 2. Spending cuts and sovereign default premia Euro area 2010Q1–2012Q2 0 2 4 6 8 10 12 14 Reduction of government consumption (percent) 0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200 Changeofdefaultpremium(basispoints) Austria Belgium Finland France Germany Greece IrelandItaly Netherlands Portugal Slovakia Slovenia Spain Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 1/20
  • 3. Does austerity pay off? Does austerity cause the sovereign default premium to decline? And, if so, when and under which circumstances? Default premium: market-based assessment of debt sustainability, reflecting Fiscal fundamentals/capacity, often not directly observed (Arellano, 2008; Bi, 2012) Market sentiment (Calvo, 1988; Cole and Kehoe, 2000; De Grauwe and Ji, 2012; Roch and Uhlig, 2015) Financing costs Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 2/20
  • 4. Three contributions 1. New panel-data set for 38 emerging and developed economies Sovereign default premium Exhaustive government consumption 2. Estimate effect of government consumption on default premium State of public finances: fiscal stress vs. benign times Size of fiscal measure: in particular spending cut vs. increase Time horizon: short vs. long run 3. Rationalize results in structural model of sovereign default Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 3/20
  • 5. Literature Recent work on spreads Longstaff et al. (2011), Borri and Verdelhan (2011), Broner, Lorenzoni, and Schmukler (2013), Bernoth, von Hagen, and Schuknecht (2012). . . Classic studies of consolidation episodes and narrative approaches Giavazzi and Pagano (1990), Alesina and Perotti (1995), Ramey and Shapiro (1998), Devries et al. (2011), Jord´a and Taylor (2013), Beetsma, Furtuna, and Giuliodori (2016) . . . State dependence Perotti (1999), Christiano, Eichenbaum, and Rebelo (2011), Auerbach and Gorodnichenko (2012), Corsetti et al. (2013), Ilzetzki, Mendoza, and V´egh (2013), Ramey and Zubairy (2014) . . . Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 4/20
  • 6. New data set covering 38 countries (1991Q1–2014Q2) Three time series for emerging and developed economies (baseline) Government consumption (Ilzetzki et al, 2013) GDP Sovereign default premium Default premium: sovereign yield vis-`a-vis riskless reference country, measured in common currency Emerging markets: J.P. Morgan EMBI spreads Euro area: long-term interest rate for convergence purposes European countries’ foreign-currency government bonds CDS spreads available at end of sample for some countries Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 5/20
  • 7. Identify fiscal shocks in smooth-transition VAR Vector of endogenous variables Xi,t = log(gi,t), log(yi,t), ∆si,t Identification (Blanchard and Perotti, 2002) Within quarter, government consumption predetermined Smooth-transition VAR (Auerbach and Gorodnichenko, 2012) Xi,t = F(zi,t)ΛA(L)Xi,t−1 + [1 − F(zi,t)] ΛB(L)Xi,t−1 + νi,t Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 6/20
  • 8. Weighting function: cdf of actual default premium 0 5 10 15 20 Default premium (pps) 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Cumulativedensity Full Sample Developed Emerging Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 7/20
  • 9. Results for VAR Estimate effect of a cut of government consumption Unbalanced panel for 38 countries, 1991Q1 to 2014Q2 (≈ 2300 observations) Include country-specific constant/trend and time-fixed effects Weighting function country-group specific Impulse responses to cut of government consumption by 1 percent Cumulative response of default premium ∆si,t, as well as response of government consumption and output Bootstrapped 90%-confidence bounds Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 8/20
  • 10. Response to fiscal shock depends on fiscal stress Government consumption 0 5 10 15 20 -1 -0.8 -0.6 -0.4 -0.2 0 GDP 0 5 10 15 20 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 5 10 15 20 -10 -5 0 5 10 (a) Unconditional VAR Government consumption 0 5 10 15 20 -1 -0.8 -0.6 -0.4 -0.2 0 Stress No stress GDP 0 5 10 15 20 -0.4 -0.3 -0.2 -0.1 0 0.1 Default premium (basis points) 0 5 10 15 20 -20 -15 -10 -5 0 5 (b) Conditional: fiscal stress vs. no stress Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 9/20
  • 11. Austerity pays off, but only in the long run Government consumption 0 20 40 60 80 -1 -0.8 -0.6 -0.4 -0.2 0 0.2 Stress No stress GDP 0 20 40 60 80 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 20 40 60 80 -30 -20 -10 0 10 Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 10/20
  • 12. Zoom in on short-run dynamics: further evidence on response of default premium (based on local projections) Gov. consumption cut (symmetric model) 0 1 2 3 4 5 -50 0 50 100 No Stress Stress Large Shock Gov. consumption cut 0 1 2 3 4 5 -50 0 50 100 Gov. consumption hike 0 1 2 3 4 5 -50 0 50 100 Size of shock matters too (large: shock is > 2SE) Premium rises disproportially in response to large cuts Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 11/20
  • 13. Results are robust. . . Additional control variables Figure Excluding Great Recession Figure Number of sample splits (e.g. advanced vs. emerging) Figure Conservative data quality sample Figure Including stock market indices Figure Confidence Figure Cross-sectional heterogeneity: mean-group estimator Figure Monetary union/dollarization vs. own legal tender Figure Excluding IMF program countries Figure Boom vs. recession Figure Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 12/20
  • 14. Concern 1: Reverse causality Main finding Cutting government consumption raises default premium in short run, if fiscal stress high Co-movement caused by premium? Ruled out under our identification scheme... Support for assumption that gov. consumption is predetermined Isolate common factor of default premium in cross section of panel (principal component) Project country-specific variables on common factor Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 13/20
  • 15. Response to common factor of sovereign default premium Government consumption reacts with delay only Government consumption 0 1 2 3 4 5 6 7 8 -3 -2 -1 0 1 2 3 ×10 -3 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -4 -3 -2 -1 0 1 ×10 -3 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -20 0 20 40 60 Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 14/20
  • 16. Concern 2: Fiscal foresight Fiscal policy innovations possibly anticipated (Leeper, Walker, and Yang, 2012; Ramey, 2011) Information sets of econometrician and agents not aligned Structural shocks not recoverable from observables: “nonfundamentalness” (Lippi and Reichlin, 1994) Local projection Replace government consumption with forecast error compiled by OECD Available for subsample of OECD countries (semi-annual observations) Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 15/20
  • 17. Response of premium to government consumption Anticipation effects—if anything—seem to dampen spread response Default premium (basis points) 0 1 2 3 4 5 6 7 8 -40 -20 0 20 40 No Stress Stress (a) Forecast error Default premium (basis points) 0 1 2 3 4 5 6 7 8 -30 -20 -10 0 10 20 30 (b) Actual consumption Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 16/20
  • 18. Zoom in on short-run dynamics: theory Robust—and (perhaps) surprising—feature of data Cutting government consumption raises default premium in short run, if fiscal stress high Structural model of sovereign default Minimal departure from workhorse model of Arellano (2008) Exogenous variation of government consumption and multiplier effect of 0.7 Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 17/20
  • 19. Model simulation: response of default premium 2 4 6 8 -50 -25 0 25 50 DefaultPremium(basispoints) Government consumption hike (1 SE) No stress Stress 2 4 6 8 -50 -25 0 25 50 Government consumption cut (1 SE) 2 4 6 8 -50 -25 0 25 50 Government consumption cut (3 SE) Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 18/20
  • 20. Model: pricing of default risk actuarially fair International investors risk neutral, demand premium according to (prob. of default: δt) 1 + rt = 1 + r 1 − δt Higher premium reflects higher prob. of default Lower government consumption reduces output Resource costs of default decline (Arellano, 2008) Incentives to default increase temporarily Effect non-linear Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 19/20
  • 21. Conclusion Does austerity pay off? Yes, but only in the long run: default premium declines in response to spending cut after about 1-2 years Short run (& fiscal stress): output declines and premium rises Markets not “schizophrenic” about austerity (Blanchard, 2011) Output loss makes default more likely in short run: default premium rises Premium falls, as output recovers Naive observer may conclude that “austerity is not working” Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 20/20
  • 22. Local projections Jord´a (2005), Granger and Ter¨asvirta (1993), Auerbach and Gorodnichenko (2013) Impulse response to government-consumption shock xi,t+h =F (zi,t) ψA,hεg i,t + [1 − F (zi,t)] ψB,hεg i,t + ui,t+h Consider first equation of VAR model (under Blanchard-Perotti) gi,t = F (zi,t) ΓA(L)Xi,t−1 + [1 − F (zi,t)] ΓB(L)Xi,t−1 + εg i,t Combining (and adding deterministics) yields local projection xi,t+h = αi,h + βi,ht + ηt,h + F (zi,t) ψA,h gi,t + [1 − F (zi,t)] ψB,h gi,t + squares and cross terms of lags + ui,t+h Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 21/20
  • 23. Impulse response functions Response in period t + h, conditional on experiencing state indexed by zi,t: ∂xt+h ∂εg i,t zi,t = F (zi,t) ψA,h + [1 − F (zi,t)] ψB,h Measures average response of economy in state zi,t going forward Conditional linearity allows using Wald-type test for assessing significance of different responses Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 22/20
  • 24. Results for local projections Estimate effect of a cut of government consumption Unbalanced panel for 38 countries (≈ 2300 observations) Include country-specific constant/trend and time-fixed effects Weighting function country-group specific Impulse responses to cut of government consumption by 1 percent Estimate panel model for horizon of up to 8 quarters; less reliable for longer horizons (Ramey, 2012) Confidence bounds based on Driscoll and Kraay (1998) standard errors: robust to heteroskedasticity, serial, and cross-sectional correlation Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 23/20
  • 25. Response to fiscal shock depends on fiscal stress Government consumption 0 1 2 3 4 5 6 7 8 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 GDP 0 1 2 3 4 5 6 7 8 -0.2 -0.15 -0.1 -0.05 0 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -2 0 2 4 6 (a) Unconditional LP Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 (b) Conditional: fiscal stress vs. no stress times Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 24/20
  • 26. Spending cuts vs. increases and small vs. large Include positive and negative structural shocks separately xi,t+h = F (zi,t) ψ− A,h ˆεg− i,t + [1 − F (zi,t)] ψ− B,h ˆεg− i,t + F (zi,t) ψ+ A,h ˆεg+ i,t + [1 − F (zi,t)] ψ+ B,h ˆεg+ i,t + . . . + ui,t Allow for different effect of large shocks (cuts and hikes) xi,t+h = F (zi,t) ψA,h ˆεg i,t + [1 − F (zi,t)] ψB,h ˆεg i,t + F (zi,t) ψbig A,h ˆεg i,t1>2SE + [1 − F (zi,t)] ψbig B,h ˆεg i,t1>2SE + . . . + ui,t Introduction Data VAR evidence Short run Interpretation Conclusion Appendix 25/20
  • 27. Exhaustive government consumption Refers to a national accounting concept: goods purchased/produced by the government for final consumption → mostly wages, goods and services purchases, and benefits in kind while excluding monetary transfers By definition includes “social transfers in kind related to expenditure on products supplied to households via market producers” (different from US) Different than “government expenditure” which often denotes all cash outlays by the government Should be accrual-based, not cash-based Excludes government investment Still based on SNA95 (next revision will use SNA2010 where available) Relates to general or central government depending on the country back Appendix References 26/20
  • 28. Construction of default premium: two examples Italy 1990 1995 2000 2005 2010 0 2 4 6 8 10 Spread Yield Benchmark United Kingdom 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 0 2 4 6 8 B1 B1 B1+B2 Long Term Convergence Rates B2 CMA CDS TR CDS B2 Appendix References 27/20
  • 29. Gov. consumption: quarterly data for 38 countries Country first obs last obs min max mean std Argentina 1994Q1 2013Q3 0.12 0.18 0.14 0.02 Australia 2003Q2 2010Q3 0.17 0.18 0.17 0.00 Austria 1994Q1 2014Q1 0.18 0.21 0.19 0.01 Belgium 1995Q1 2014Q1 0.21 0.25 0.23 0.01 Brazil 1995Q1 2014Q1 0.19 0.23 0.20 0.01 Bulgaria 1999Q1 2014Q1 0.14 0.20 0.18 0.02 Chile 1999Q3 2014Q2 0.05 0.06 0.06 0.00 Colombia 2000Q1 2014Q1 0.15 0.17 0.16 0.01 Croatia 2004Q2 2014Q1 0.18 0.21 0.20 0.01 Czech Republic 2004Q2 2014Q1 0.19 0.22 0.21 0.01 Denmark 1991Q1 2014Q1 0.25 0.30 0.26 0.01 Ecuador 1995Q2 2014Q1 0.09 0.14 0.12 0.02 El Salvador 2002Q3 2014Q1 0.06 0.09 0.07 0.01 Finland 1992Q3 2014Q1 0.20 0.25 0.22 0.02 France 1999Q2 2014Q1 0.23 0.25 0.24 0.01 Germany 2004Q2 2014Q1 0.18 0.20 0.19 0.01 Greece 2000Q1 2011Q1 0.17 0.22 0.18 0.01 Hungary 1999Q2 2014Q1 0.20 0.25 0.22 0.01 Ireland 1997Q1 2014Q1 0.14 0.21 0.17 0.02 Appendix References 28/20
  • 30. Gov. consumption: quarterly data for 38 countries cont’d Country first obs last obs min max mean std Italy 1991Q1 2014Q1 0.17 0.22 0.19 0.01 Latvia 2006Q2 2014Q1 0.15 0.22 0.18 0.02 Lithuania 2005Q3 2014Q1 0.17 0.22 0.19 0.02 Malaysia 2000Q1 2014Q1 0.07 0.12 0.10 0.01 Mexico 1994Q1 2014Q2 0.00 0.00 0.00 0.00 Netherlands 1999Q2 2014Q2 0.20 0.27 0.24 0.02 Peru 1997Q2 2014Q2 0.07 0.09 0.08 0.01 Poland 1995Q1 2014Q1 0.17 0.20 0.18 0.01 Portugal 1995Q1 2014Q1 0.17 0.22 0.19 0.01 Slovakia 2004Q2 2014Q1 0.17 0.20 0.18 0.01 Slovenia 2003Q2 2014Q1 0.17 0.21 0.19 0.01 South Africa 1995Q1 2014Q1 0.18 0.23 0.20 0.01 Spain 1995Q1 2014Q1 0.17 0.22 0.19 0.02 Sweden 1993Q2 2014Q2 0.07 0.10 0.08 0.01 Thailand 1997Q3 2014Q2 0.10 0.14 0.12 0.01 Turkey 1998Q1 2014Q1 0.10 0.16 0.13 0.01 United Kingdom 1993Q1 2013Q4 0.17 0.23 0.20 0.02 United States 2008Q1 2014Q1 0.15 0.17 0.16 0.01 Uruguay 2001Q3 2014Q1 0.10 0.14 0.11 0.01 Appendix References 29/20
  • 31. Example: weighting functions for Italy Note: fiscal stress = recessions 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Fiscal Stress Recession Appendix References 30/20
  • 32. Local projections to establish robustness of results for the short-run Additional controls: gross public debt GDP 0 1 2 3 4 5 6 7 8 -0.3 -0.2 -0.1 0 0.1 0.2 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -40 -20 0 20 40 Debt/GDP (percentage points) 0 1 2 3 4 5 6 7 8 -1 -0.5 0 0.5 1 Debt only available for smaller sample Debt-to-GDP ratio rises during stress back Appendix References 31/20
  • 33. The response of confidence to a government spending shock GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Confidence 0 1 2 3 4 5 6 7 8 -0.06 -0.04 -0.02 0 0.02 0.04 0.06 Confidence (Ifo WES) pertains to expectations regarding economic conditions in the next 6 months. Fiscal stress: confidence is unresponsive to the spending cut No stress times: confidence tends to improve a year after spending cut → austerity less harmful whenever it improves confidence back Appendix References 32/20
  • 34. Including national stock market indices GDP 0 1 2 3 4 5 6 7 8 -0.3 -0.2 -0.1 0 0.1 0.2 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Stock market index 0 1 2 3 4 5 6 7 8 -1 -0.5 0 0.5 1 back Appendix References 33/20
  • 35. Boom vs. recession Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 Boom Recession GDP 0 1 2 3 4 5 6 7 8 -0.3 -0.2 -0.1 0 0.1 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Similar to fiscal stress vs. no stress times But: overlap between episodes is far from perfect back Appendix References 34/20
  • 36. Austerity does not pay off in times of fiscal stress (top), pre financial crisis sample (bottom) Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 back Appendix References 35/20
  • 37. Advanced (top) vs. emerging (bottom) Government consumption 0 1 2 3 4 5 6 7 8 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -60 -40 -20 0 20 40 60 Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.2 0 0.2 0.4 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -5 0 5 10 back Appendix References 36/20
  • 38. Euro area: crisis (top) vs. non-crisis countries (bottom) Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 1 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.5 0 0.5 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -80 -60 -40 -20 0 20 40 Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -1 -0.5 0 0.5 1 1.5 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 20 back Appendix References 37/20
  • 39. Full sample (top) vs. conservative sample (bottom) Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 15 Appendix References 38/20
  • 40. Cross-sectional heterogeneity: mean-group estimator Government spending 0 1 2 3 4 5 6 7 8 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0 Baseline model Mean group estimator GDP 0 1 2 3 4 5 6 7 8 -0.25 -0.2 -0.15 -0.1 -0.05 0 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 Take mean of coefficient of country-by-country regressions Only possible for unconditional model back Appendix References 39/20
  • 41. Monetary union/dollarization vs. own legal tender Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.6 -0.4 -0.2 0 0.2 0.4 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -60 -40 -20 0 20 40 60 (a) Monetary union or dollarization Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 -5 0 5 10 (b) Countries with their own legal tender back Appendix References 40/20
  • 42. Transmission GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -50 0 50 Gov. net lending/GDP (percentage points) 0 1 2 3 4 5 6 7 8 -0.2 -0.1 0 0.1 0.2 (a) Including government net lending/GDP ratio back Appendix References 41/20
  • 43. Transmission GDP 0 1 2 3 4 5 6 7 8 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -10 0 10 20 30 Consumption 0 1 2 3 4 5 6 7 8 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 (a) Including private consumption GDP 0 1 2 3 4 5 6 7 8 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 No Stress Stress Default premium (basis points) 0 1 2 3 4 5 6 7 8 -20 -10 0 10 20 30 Investment 0 1 2 3 4 5 6 7 8 -3 -2 -1 0 1 (b) Including private investment back Appendix References 42/20
  • 44. Excluding IMF program countries Government consumption 0 1 2 3 4 5 6 7 8 -1.5 -1 -0.5 0 0.5 No Stress Stress GDP 0 1 2 3 4 5 6 7 8 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 Default premium (basis points) 0 1 2 3 4 5 6 7 8 -20 -10 0 10 20 30 back Appendix References 43/20
  • 45. Bibliography I Alberto Alesina and Roberto Perotti. “Fiscal expansions and adjustments in OECD countries”. In: Economic Policy 21.10 (1995), pp. 207–248. Cristina Arellano. “Default risk and income fluctuations in emerging economies”. In: American Economic Review 98 (2008), pp. 690–712. Alan J. Auerbach and Yuriy Gorodnichenko. “Fiscal multipliers in recession and expansion”. In: Fiscal Policy after the Financial Crisis. Ed. by Alberto Alesina and Francesco Giavazzi. Chicago: University of Chicago Press, 2013, pp. 63–98. Alan J. Auerbach and Yuriy Gorodnichenko. “Measuring the output responses to fiscal policy”. In: American Economic Journal: Economic Policy 4.2 (May 2012), pp. 1–27. Appendix References 44/20
  • 46. Bibliography II Roel Beetsma, Oana Furtuna, and Massimo Giuliodori. Does the Confidence Fairy Exist? Evidence from a New Narrative Dataset on Announcements of Fiscal Austerity Measures. Tech. rep. 2016. Kerstin Bernoth, J¨urgen von Hagen, and Ludger Schuknecht. “Sovereign risk premiums in the European government bond market”. In: Journal of International Money and Finance 31.5 (2012), pp. 975–995. Huixin Bi. “Sovereign default risk premia, fiscal limits, and fiscal policy”. In: European Economic Review 56 (2012), pp. 389–410. Appendix References 45/20
  • 47. Bibliography III Olivier J. Blanchard. “2011 In review: four hard truths”. In: iMFdirect Blog. December 21, 2011, URL: http://blog-imfdirect.imf.org/2011/12/21/2011-in-review- four-hard-truths/. 2011. Olivier J. Blanchard and Roberto Perotti. “An empirical characterization of the dynamic effects of changes in government spending and taxes on output”. In: Quarterly Journal of Economics 117.4 (2002), pp. 1329–1368. Nicola Borri and Adrien Verdelhan. Sovereign risk premia. Tech. rep. 2011. Fernando A. Broner, Guido Lorenzoni, and Sergio L. Schmukler. “Why do emerging economies borrow short term?” In: Journal of the European Economic Association 11.S1 (2013), pp. 67–100. Appendix References 46/20
  • 48. Bibliography IV Guillermo A. Calvo. “Servicing the public debt: the role of expectations”. English. In: The American Economic Review 78.4 (1988), pp. 647–661. Lawrence Christiano, Martin Eichenbaum, and Sergio Rebelo. “When Is the government spending multiplier large?” In: Journal of Political Economy 119.1 (2011), pp. 78 –121. Harold L. Cole and Timothy J. Kehoe. “Self-Fulfilling Debt Crises”. In: The Review of Economic Studies 67.1 (2000), pp. 91–116. Giancarlo Corsetti, Keith Kuester, Andr´e Meier, and Gernot J. M¨uller. “Sovereign risk, fiscal policy, and macroeconomic stability”. In: Economic Journal 123.566 (Feb. 2013), F99–F132. Appendix References 47/20
  • 49. Bibliography V Paul De Grauwe and Yuemei Ji. “Mispricing of sovereign risk and macroeconomic stability in the eurozone”. In: Journal of Common Market Studies 50.6 (2012), pp. 866–880. doi: 10.1111/j.1468-5965.2012.02287.x. Pete Devries, Jaime Guajardo, Daniel Leigh, and Andrea Pescatori. A new action-based dataset of fiscal consolidation. IMF Working Paper 11/128. 2011. John C. Driscoll and Aart C. Kraay. “Consistent covariance matrix estimation with spatially dependent panel data”. In: The Review of Economics and Statistics 80.4 (Nov. 1998), pp. 549–560. Appendix References 48/20
  • 50. Bibliography VI Francesco Giavazzi and Marco Pagano. “Can severe fiscal contractions be expansionary? Tales of two small European countries”. In: NBER Macroeconomics Annual. Ed. by Olivier J. Blanchard and Stanley Fischer. Vol. 5. Cambridge, MA: MIT Press, Aug. 1990, pp. 75–122. Clive W. J. Granger and Timo Ter¨asvirta. Modelling nonlinear economic relationships. Oxford University Press, 1993. Ethan Ilzetzki, Enrique G. Mendoza, and Carlos A. V´egh. “How big (small?) are fiscal multipliers?” In: Journal of Monetary Economics 60.2 (2013), pp. 239–254. `Oscar Jord´a. “Estimation and inference of impulse responses by local projections”. In: American Economic Review 95.1 (Mar. 2005), pp. 161–182. Appendix References 49/20
  • 51. Bibliography VII `Oscar Jord´a and Alan M. Taylor. The time for austerity: estimating the average treatment effect of fiscal policy. NBER Working Papers 19414. 2013. Eric M. Leeper, Todd B. Walker, and Shu-Chun Susan Yang. Foresight and information flows. Tech. rep. 2012. Marco Lippi and Lucrezia Reichlin. “VAR analysis, non-fundamental representation, Blaschke matrices”. In: Journal of Econometrics 63 (1994), pp. 307–325. Francis A. Longstaff, Jun Pan, Lasse H. Pedersen, and Kenneth J. Singleton. “How sovereign is sovereign credit risk?” In: American Economic Journal: Macroeconomics 3.2 (2011), pp. 75–103. Roberto Perotti. “Fiscal policy in good times and bad”. In: Quarterly Journal of Economics 114.4 (Nov. 1999), pp. 1399–1436. Appendix References 50/20
  • 52. Bibliography VIII Valerie A. Ramey. “Comment on “Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment””. In: NBER Macroeconomics Annual 2012, Volume 27. NBER Chapters. National Bureau of Economic Research, Inc, Sept. 2012, pp. 147–153. Valerie A. Ramey. “Identifying government spending shocks: It’s all in the timing”. In: Quarterly Journal of Economics 126.1 (2011), pp. 1–50. Valerie A. Ramey and Matthew D. Shapiro. “Costly capital reallocation and the effects of government spending”. In: Carnegie-Rochester Conference Series on Public Policy 48 (1998), pp. 145–198. Appendix References 51/20
  • 53. Bibliography IX Valerie A. Ramey and Sarah Zubairy. Government spending multipliers in good times and in bad: evidence from U.S. historical data. NBER Working Paper 20719. Nov. 2014. Francesco Roch and Harald Uhlig. The Dynamics of Sovereign Debt Crises and Bailouts. Tech. rep. 2015. Appendix References 52/20