Long-run Effects of Austerity: An Analysis of Size Dependence and Persistence in Fiscal Multipliers

Abstract

This paper provides evidence that austerity shocks have long-run negative effects on GDP. Our baseline results show that contractionary fiscal shocks larger than 3% of GDP generate a negative effect of more than 5.5% on GDP even after 15 years. Evidence is also found linking austerity to smaller capital stock and total hours worked in the long-run. The results are robust to different fiscal shock datasets, the exclusion of particular shocks, and the use of cleaner controls. The paper also engages with the emerging discussion regarding fiscal multipliers heterogeneity, presenting evidence that the effects of exogenous fiscal measures are nonlinear on the shock size. The results also contribute to the broader discussion on the long-run effects of demand by suggesting that such shocks might permanently affect the economy.