Publication: Expansionary Fiscal Austerity: New International Evidence
The expansionary fiscal contraction (EFC) hypothesis states that fiscal austerity can increase output or consumption when a country is under heavy debt burdens because it sends positive signal about the country's solvency situation and long-term economic wellbeing. Empirical tests of this hypothesis have suffered from identification concerns due to data sources and empirical methodology. Using a sample of OECD countries between 1978 and 2014, this paper combines new IMF narrative data and the proxy structural Vector Auto-regression (SVAR) method to examine whether fiscal austerities can be expansionary when debt levels are high. Fiscal austerities are measured as 1) narrative fiscal shocks and 2) structural shocks from a proxy SVAR. Additionally, this paper uses a model-based approach to determine the cutoff debt level beyond which EFC is expected to be observed. This paper finds empirical evidence in support of the EFC hypothesis for OECD countries: results for output are driven by changes in tax rates and are robust to how one defines a high-debt regime and how one measures austerity.
Link to Data Set
“Nie, Ou. 2020. Expansionary Fiscal Austerity: New International Evidence. Policy Research Working Paper;No. 9344. © World Bank, Washington, DC. http://hdl.handle.net/10986/34262 License: CC BY 3.0 IGO.”
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