Austerity, Fiscal Uncertainty, and Economic Growth: Insights from Fiscally Weak EU Countries

SAFE Working Paper No. 56

42 Pages Posted: 27 Jun 2014 Last revised: 25 Feb 2015

See all articles by Giuliano Curatola

Giuliano Curatola

University of Siena - Department of Economics and Statistics; Leibniz Institute for Financial Research SAFE

Michael Donadelli

University of Brescia

Alessandro Gioffré

University of Florence - Department of Economics and Management; Leibniz Institute for Financial Research SAFE

Patrick Grüning

Latvijas Banka

Date Written: August 8, 2014

Abstract

Recent empirical evidence suggests that during the last years fiscally weak European countries significantly cut their R&D budgets in an effort to reduce their deficit, according to the spirit of the Fiscal Compact. We propose a general equilibrium model that endogenously captures the trade-off between costs and benefits of austerity measures driven by a zero-deficit policy. Our analysis suggests that cuts in R&D spending undermine economic growth both in the short and the long run. We use our model to estimate the reduction of economic growth due to R&D cuts implemented by fiscally weak European countries during the period 2010-2012. The model predicts a reduction in real growth by 0.63%, 2.93%, and 4.46%, in the next 1, 5, and 10 years, respectively. Moreover, we show that the zero-deficit constraint hampers economic growth in the presence of either a productivity drop or a spending stimulus.

Keywords: Austerity Measures, Fiscal Policy, Endogenous Growth, R&D

JEL Classification: G12, G15

Suggested Citation

Curatola, Giuliano and Donadelli, Michael and Gioffré, Alessandro and Grüning, Patrick, Austerity, Fiscal Uncertainty, and Economic Growth: Insights from Fiscally Weak EU Countries (August 8, 2014). SAFE Working Paper No. 56, Available at SSRN: https://ssrn.com/abstract=2458855 or http://dx.doi.org/10.2139/ssrn.2458855

Giuliano Curatola

University of Siena - Department of Economics and Statistics ( email )

Piazza San Francesco 7
Siena, Siena 53100
Italy

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Michael Donadelli

University of Brescia ( email )

Piazza del Mercato, 15
25122 Brescia
Italy

Alessandro Gioffré

University of Florence - Department of Economics and Management ( email )

Via delle Pandette, 9
Firenze, Florence 50127
Italy

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Patrick Grüning (Contact Author)

Latvijas Banka ( email )

K. Valdemāra iela 2A
Riga, 1050
Latvia

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