Austerity Measures The Effect Of Government Spending Shocks In The Context Of The Sovereign Debt Crisis

This paper discusses the effect of government spending shocks on economic performance in the European debt crisis with a particular focus on spending based consolidation. It examines the question whether the following economic environment conditions alter the fiscal transmission mechanism of government spending shocks: fixed exchange rate, fiscal strain, financial crisis and the zero lower bound of nominal interest. These are relevant for countries affected by the crisis. While there is extensive research on government spending shocks and also on differences in their effects across economic environments, there is no specific application of this kind of research to the cumulative conditions as found in the European sovereign debt crisis. Therefore, the effects of spending shocks are estimated in a baseline scenario of an unconstrained open economy and subsequently compared with an extended model controlling for the relevant environment variables. The empirical cross-country analysis of 30 OECD countries over the last three decades aims to estimate the effects in a two-stage regression model, which first identifies a series of fiscal shocks and subsequently estimates the pooled effect of those shocks on key macroeconomic variables. It is found that positive government spending shocks exert a negative but not significant effect on economic performance and the demand channel, both in the baseline model and when applying constraints relevant to the sovereign debt crisis.