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Unit 4 Macro: New research on fiscal austerity and the sovereign debt crisis

The latest edition of the Economics Journal publishes some new macroeconomic research on the vexed issue of fiscal austerity. Below are some of the summaries of these research papers.

FISCAL CONSOLIDATION WILL NOT BOOST GROWTH

Current efforts at fiscal consolidation are unlikely to raise economic growth, according to research by Huixin Bi, Eric Leeper and Campbell Leith, published in the latest issue of the Economic Journal. Their study shows that an expansionary fiscal consolidation is conceivable in a very particular set of conditions – but these conditions are unlikely to be fulfilled in the foreseeable future.

What’s more, the researchers conclude, even if it were possible to engineer the conditions for an expansionary fiscal consolidation, it is unlikely to be a good thing. The policy relies on depressing the economy by leading households and firms to believe that one debt reduction strategy will be followed, only to induce a boom by implementing a different, less costly, policy. In other words, it works by fooling people, which is rarely desirable. Debt reduction is, inevitably, a long and painful process.

‘FISCAL SPACE’: A NEW MEASURE OF THE SUSTAINABILITY OF PUBLIC DEBT

Greece, Iceland, Italy, Japan and Portugal all have limited or no available room for fiscal manoeuvre before markets force them to tighten policies sharply, raising taxes and/or cutting government spending in order to restore or maintain the sustainability of public debt.

That is one of the findings of research by Atish Rex Ghosh and colleagues, which develops a measure of ‘fiscal space’ – the distance between the current level of public debt and the maximum level that is compatible with fiscal solvency – and applies the methodology to a sample of advanced economies.

Their study, which is published in the latest issue of the Economic Journal, finds ample fiscal space for Australia, Korea and the Nordic countries. For the UK and the United States, the study finds around 50-75% of GDP of remaining fiscal space.

SOVEREIGN RISK: THE IMPACT OF STRAINED GOVERNMENT FINANCES ON MACROECONOMIC STABILITY

When the economy is flat-lining or in recession, fiscal stimulus will only be effective when concerns about sovereign risk (the possibility that the government will default on its debt) are contained. That is the central conclusion of research by Giancarlo Corsetti, Keith Kuester, André Meier and Gernot Müller, published in the latest issue of the Economic Journal.

Their study explores how policy-makers can preserve macroeconomic stability in a situation where fears about sovereign default drive up risk premia for banks, firms and the wider economy. The threat to stability becomes acute when public debt is high and monetary policy is at the zero lower bound. Once the central bank has exhausted the room for further monetary easing, government spending cuts can become a critical tool to avert self-fulfilling crisis dynamics.

What’s more, government spending cuts are less harmful to growth in the presence of the ‘sovereign risk channel’ through which high public indebtedness raises funding costs in the private sector and dampens overall economic activity. The researchers conclude:

‘Our results underscore the importance of keeping the public finances under control during good times.

‘Only when concerns about sovereign risk are contained, do fiscal policy-makers retain the capacity to enact effective fiscal stimulus during bad times.’

REDISTRIBUTION AND PUBLIC DEBT AS WAYS TO BOOST THE ECONOMY

A ‘Robin Hood’-style redistribution policy, which takes money from the rich and gives it to the poor, can boost consumption and output, although at the cost of higher inflation. So too can an increase in public debt that is used to transfer resources to everyone.

These are among the conclusions of research by Florin Bilbiie, Tommaso Monacelli and Roberto Perotti, published in the latest issue of the Economic Journal. One of the key insights of their study is that public debt is equivalent to redistribution.

Unit 4 Macro: Taking the Pulse of Africa - Growth Outlook is Good [16 Apr 2013]
Unit 2 Macro: Revision on Interest Rates [6 Apr 2013]
Unit 1 Micro: Externalities of Piracy in Somalia [4 Apr 2013]
Unit 4 Macro: Growth and Development in Angola [3 Apr 2013]
Unit 2 Macro: Revise and Test - Aggregate Demand [28 Mar 2013]
Unit 4 Macro: The AAA Credit Rating Downgrade [23 Feb 2013]
Unit 1 Micro: Falling Car Use among Younger Drivers [18 Feb 2013]
Unit 4 Macro: The UK Economy and the Euro [10 Feb 2013]
Unit 2 Macro: Zombie Households and the Slow Recovery [18 Jan 2013]
Unit 4 Macro: Overseas Aid and Economic Development - Debt Relief and Debt Cancellation [17 Jan 2013]
Unit 4 Macro: Fair Trade and Development [12 Jan 2013]
Unit 4 Macro: The Failure of Austerity [5 Jan 2013]
Unit 1 Micro: Information Failure in Cosmetic Surgery [3 Jan 2013]
Prospects for the UK Economy in 2013 [2 Jan 2013]
Floods: awash with economics [27 Nov 2012]
Unit 4 Macro: Mo Tanweer - Debunking the Myths of China [27 Nov 2012]
Unit 4 Macro: Paul Collier on Key Development Issues [26 Nov 2012]
Macro Policy: A Lost Decade for the West? [19 Nov 2012]
Chocolate Passion - Grown in St Lucia, Made in Cambridge [9 Nov 2012]
Paul Ormerod: Don’t say IMF, it’s IMF Squared! [18 Oct 2012]
Paul Ormerod: Policy makers have learned from the mistakes of the 1930s [11 Oct 2012]
Unit 2 Macro: The UK Economy - What Would Keynes Do? [7 Oct 2012]
Unit 4 Macro: Agri-Chemicals and Infant Mortality in India [25 Sep 2012]
Unit 4 Macro: Primary Export Dependence [15 Sep 2012]
Unit 4 Macro: Micro-insurance and development [15 Sep 2012]
Unit 4 Macro: Micro-insurance for Kenyan Farmers [26 Jul 2012]
Unit 2 Macro: The Funding for Lending Scheme [19 Jul 2012]
Unit 4 Macro: Fiscal Policy in the UK - A Question of Credibility [12 Jul 2012]
Unit 3 Micro: Barclays receives massive fine for price fixing [9 Jul 2012]
Unit 4 Macro: Malnutrition and Economics Development [8 Jul 2012]
Behavioural Economics: Compulsory Breathalysers [2 Jul 2012]
Growing the Warburtons Brand - Focusing on Core Values [25 Jun 2012]
Unit 3 Micro: Sunk Costs [9 Jun 2012]
End Depression Now! Paul Krugman at the LSE [30 May 2012]
Unit 3 Micro: Game Theory and Business Economics [21 May 2012]
Unit 2 Macro: UK Trade in Services [20 May 2012]
Unit 2 Macro: Bank Cuts UK growth Forecast for 2012 [17 May 2012]
Unit 1 Micro: Asymmetric Information [12 May 2012]
Unit 1 Micro: De-Merit Goods [12 May 2012]
Unit 2 Macro: Government Spending [11 May 2012]
Unit 2 Macro: Revision Notes on Supply-side Policies [10 May 2012]
Unit 2 Macro: Monetary Policy and Inflation Glossary [5 May 2012]
Unit 2 Macro: Trade and Balance of Payments Glossary [5 May 2012]
Unit 2 Macro: Fiscal Policy Glossary [5 May 2012]
Macro Revision: Putting Things in Context [29 Apr 2012]
Unit 4 Macro: The Euro Zone Crisis (Revision) [22 Apr 2012]
Unit 2 Macro: Revision on Interest Rates and the Exchange Rate [3 Apr 2012]
Unit 1 Micro: The Collapsing Price of Carbon [3 Apr 2012]
Unit 4 Macro: Floating and Managed Floating Exchange Rates [2 Apr 2012]
Unit 4 Macro: Pain in Spain as Fiscal Austerity Bites [1 Apr 2012]
Posen on slower growth in the UK compared to the USA [30 Mar 2012]
Unit 2 Macro: Revision on Capital Investment [30 Mar 2012]
Blanchflower calls for more action to address youth jobless crisis [28 Mar 2012]
George Buckley at the Millfield Economics Society [28 Mar 2012]
Beyond the Bike - Monetary Policy in Africa [28 Mar 2012]
Unit 4 Macro: Evaluating 3 Years of Quantitative Easing [27 Mar 2012]
Unit 1 Micro: Government launches New Buy Loan Guarantee Scheme [12 Mar 2012]
Unit 2 Macro: Policies to Drive Economic Recovery [9 Mar 2012]
Unit 4 Macro: Sovereign Wealth Funds [4 Mar 2012]
Mortgage interest rates, LIBOR and game theory [3 Mar 2012]
The Economics of Climate Change - Stern 5 Years On [21 Feb 2012]
A return to Glass-Steagall to prevent another crash? A lesson from economic history. [17 Feb 2012]
Unit 4 Macro: King on the UK Economy [15 Feb 2012]
Martin Wolf on Global Shocks [10 Feb 2012]
Unit 1 Micro: Can the UK Computer Games Industry Grow [24 Jan 2012]
Unit 4 Macro: Money, Debt and the New World Order [22 Jan 2012]
Unit 4 Macro: Russia Joins the WTO [22 Jan 2012]
Unit1 Micro: Processed Meat and Cancer Risk - Information Failure? [17 Jan 2012]
Unit 2 Macro: Frontier Markets - the New BRICS? [15 Jan 2012]
Beyond the Bike - The Importance of Remittances [15 Jan 2012]
Unit 4 Macro: Economics of Fiscal Deficit Reduction [12 Jan 2012]
Unit 4 Macro: UK Bond Yields Reach Record Lows [11 Jan 2012]
Unit 2 Macro: Quantitative Easing in the UK [8 Jan 2012]
Unit 4 Macro: Natural Disasters and their Economic Impact [7 Jan 2012]
Unit 4 Macro: Exchange Rate Economics - Where next for the US Dollar? [31 Dec 2011]
Unit 2 Macro: The UK Housing Market in 2011 [26 Dec 2011]
Economics of Deforestation [20 Dec 2011]
Unit 2 Macro: Mobile Phones and African Economic Growth [18 Dec 2011]
Beyond the Bike - What is the value of life in Africa? [19 Nov 2011]
Beyond the Bike - The Value of Money [19 Nov 2011]
LSE Lecture: Daniel Kahneman - Thinking Fast and Slow [15 Nov 2011]
Unit 2 Macro: Should the EU introduce a Tobin Tax? [15 Nov 2011]
Unit 1 Micro: Asymmetric Information - Buying a Used Car [14 Nov 2011]
AS Macro: The State of British Business [13 Nov 2011]
Eurozone crisis - a selection of resources [12 Nov 2011]
Unit 4 Macro: Should TNCs make full disclosure on factory wages? [30 Oct 2011]
Unit 3 Micro: UK Executive Pay - All in it Together? [29 Oct 2011]
Can the “invisible hand” solve Africa’s poverty? [13 Oct 2011]
Why Is Macroeconomics Such A Mess? [11 Oct 2011]
Unit 3 Micro: Tube Drivers set to earn £50,000 a year [3 Oct 2011]
Unit 1 Micro: Drink Driving and Government Intervention [26 Sep 2011]
Greek debt decision tree [25 Sep 2011]
Unit 4 Macro: IMF Flags up Risks of Double Dip [20 Sep 2011]
UK Macro: Risks of a Double Dip Recession [12 Sep 2011]
Mixing with the Nobel Economists [4 Sep 2011]
Monetary Policy Roundtable [25 Jul 2011]
Unit 4 Macro: Dangers of High Inflation [11 Jul 2011]
Where there’s muck there’s brass [6 Jul 2011]
Global Economy: Increased risk of future shocks [28 Jun 2011]
AS Macro Key Term: Deflation [24 May 2011]

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