Does Austerity Pay Off?


It depends. In this paper we investigate empirically how the sovereign default premium responds to fiscal shocks – specifically to unanticipated and exogenous changes of government consumption growth. For this purpose we assemble a new data set for 38 emerging and developed economies. It contains approximately 3,000 observations for the sovereign default premium and three alternative measures of fiscal shocks. We rely on local projections to estimate the impact of these shocks and condition on a) whether shocks are positive or negative and b) initial conditions in terms of fiscal stress. We find that an increase of government consumption hardly affects the default premium. Instead, a reduction raises the premium if fiscal stress is severe, but decreases it if initial conditions are more benign.

Review of Economics and Statistics, accepted