When neighbors tighten belts: Exploring austerity’s spillover effects

Abstract

This study investigates the impact of domestic austerity measures and their spillover effects when synchronized among trading partners, focusing on their influence on domestic GDP growth and public debt-to-GDP ratios. Using a novel narrative dataset covering 17 OECD countries from 1978 to 2020 and 14 Latin American and Caribbean countries from 1989 to 2020, the findings reveal that domestic austerity measures significantly depress GDP growth and escalate public debt ratios, while spillover effects from foreign fiscal consolidations can sometimes surpass the impacts of domestic adjustments. Fiscal spillovers affect economic growth in OECD countries and public debt dynamics in the LAC region. Notably, they are particularly pronounced in more trade-open OECD members and during economic downturns in both LAC and OECD countries. Interestingly, OECD countries with lower trade openness and economies going through expansionary phases of the business cycle exhibit positive responses to austerity measures from trade partners. These findings underscore the complex interdependencies in global fiscal policy and highlight the necessity for coordinated approaches to mitigate adverse effects and leverage positive responses during varying economic conditions.