Dynamic Fiscal Multipliers: Why Austerity Has Failed in the Euro Area
European Economist
Research Associate*
March 20, 2013
The pressing need to address high levels of public-sector debt on both sides of the Atlantic has prompted a renewed interest in fiscal multipliers—the impact that policy-driven changes in taxation and government spending have on economic output.
There is good reason for this. If the multiplier is low (or negative), there are obvious benefits to tightening fiscal policy early and aggressively. But if the multiplier is high, a tightening of fiscal policy is likely to have a hugely damaging impact on output and might even be self-defeating. In such a case it would be better to delay austerity until the economy has recovered.
Nowhere is the debate about multipliers more heated than in the euro area. To shed some light on this controversy, we looked at 168 cases of fiscal consolidation to see how they worked out in practice. Our research showed that successful fiscal adjustment depends on several clearly identifiable factors:
- the size and duration of the adjustment itself;
- the flexibility of the exchange rate and the economy’s openness to international trade; and
- the tightness of credit conditions.
These factors have not been favorable in the euro area, which is why fiscal tightening has been so corrosive. In view of the backlash against austerity now evident in parts of the euro area’s periphery, Europe’s leaders urgently need to find a new approach before the public turns its back on the euro itself.
Factors Influencing the Likely Success/Failure of a Fiscal Consolidation
