The "Austerity Myth": Gain Without Pain?

58 Pages Posted: 4 Nov 2011 Last revised: 7 Jul 2023

See all articles by Roberto Perotti

Roberto Perotti

Bocconi University - Department of Economics; European University Institute - Economics Department (ECO); Centre for Economic Policy Research (CEPR)

Date Written: November 2011

Abstract

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.

Suggested Citation

Perotti, Roberto, The "Austerity Myth": Gain Without Pain? (November 2011). NBER Working Paper No. w17571, Available at SSRN: https://ssrn.com/abstract=1954498

Roberto Perotti (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

European University Institute - Economics Department (ECO) ( email )

Villa San Paolo
Via della Piazzuola 43
50133 Florence
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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