Fiscal austerity might not have hurt growth in the Great Recession

I say 'might', but of course I don't think there's any evidence it did. Anyway, a new NBER paper (gated up to date version, full working paper pdf) from Alberto Alesina, Omar Barbiero, Carlo Favero, Francesco Giavazzi and Matteo Paradisi finds that it did not.

The conventional wisdom is (i) that fiscal austerity was the main culprit for the recessions experienced by many countries, especially in Europe, since 2010 and (ii) that this round of fiscal consolidation was much more costly than past ones.

The contribution of this paper is a clarification of the first point and, if not a clear rejection, at least it raises doubts on the second. In order to obtain these results we construct a new detailed "narrative" data set which documents the actual size and composition of the fiscal plans implemented by several countries in the period 2009-2013. Out of sample simulations, that project output growth conditional only upon the fiscal plans implemented since 2009 do reasonably well in predicting the total output fluctuations of the countries in our sample over the years 2010-13 and are also capable of explaining some of the cross-country heterogeneity in this variable.

Fiscal adjustments based upon cuts in spending appear to have been much less costly, in terms of output losses, than those based upon tax increases. The difference between the two types of adjustment is very large. Our results, however, are mute on the question whether the countries we have studied did the right thing implementing fiscal austerity at the time they did, that is 2009-13.

Finally we examine whether this round of fiscal adjustments, which occurred after a financial and banking crisis, has had different effects on the economy compared to earlier fiscal consolidations carried out in "normal" times. When we test this hypothesis we do not reject the null, although in some cases failure to reject is marginal. In other words, we don't find sufficient evidence to claim that the recent rounds of fiscal adjustment, when compared with those occurred before the crisis, have been especially costly for the economy.

The paper comes with a whole load of interesting charts, showing how much newspapers started talking about austerity in 2010, the evolution of Eurozone fiscal policy, the correspondence between different measures of governments' fiscal policy stances, and how much better cutting spending is as a means of belt tightening than raising taxes (contrary to what Keynesian intermediate macro textbooks tell you).

Screen Shot 2015-01-12 at 15.52.32 Screen Shot 2015-01-12 at 15.52.38 Screen Shot 2015-01-12 at 15.52.47 Screen Shot 2015-01-12 at 15.52.58Interestingly, they don't make much mention of monetary policy whether conventional or unconventional. Of course, I believe that fiscal austerity would hurt growth if monetary policymakers weren't willing and able to steady aggregate demand. But so would a particular large firm, for example, reducing investment if this was also coupled with the central bank deciding to cut its nominal target for some reason.