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Comments on“Does austerity pay off? ”
Johannes Pfeifer, Benjamin Born, Gernot J. Müller
António Afonso(ISEG/UL-School of Economics and Management, University of Lisbon;
UECE-Research Unit on Complexity and Economics)
06-06-2016
A. Afonso
Source: How the case for austerity crumbled, Paul Krugman, The New
York Review of Books, June 2013.
2A. Afonso
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• Assesses whether reducing government
consumption lowers the sovereign default premium.
• The results, for a group of 38 countries [1991Q1-
2014Q2], indicate that cuts in government
consumption increase sovereign yield spreads,
although the effect may be reversed in the long run.
• The baseline result uses a panel-VAR framework.
The results are somewhat kept using a local
projection framework.
3A. Afonso
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• Main result: cuts in government consumption
increase sovereign yield spreads.
• This might occur because the lower ensuing level of
GDP can lead the fiscal authorities to default on the
debt service in order to shift resources to other
spending items.
• The paper argues that “a cut of governmentconsumption may trigger a further increase of the defaultpremium, because markets correctly foresee a heightenedtemptation to default. This temptation lasts as long asoutput remains depressed”.
4A. Afonso
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1. The paper uses sovereign yield spreads as a proxy
for default premium. Why not simply call it yield
spread?
2. The result that reducing government consumption
increases yield spreads is less obvious. Indeed,
several studies find that improving fiscal balances
reduce sovereign yield spreads, notably in crisis
periods (Afonso, Arghyrou, Kontonikas, 2014;
Afonso, Rault, 2015).
3. The paper mixes General Government and Central
Government consumption. This seems less
adequate since the respective ratios-to-GDP are
rather different (spreading from 0.3% to 30%).
5A. Afonso
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4. The use of government consumption to identify
fiscal shocks is a possibility. However, one can also
consider the more usual CAPB measure or even the
so-called narrative action-based data.
5. Therefore, one note of caution is in order, notably
given the results reported, which may not be
invariant to the chosen fiscal measure.
6. For instance, the response of GDP to fiscal
consolidations differs between positive and negative
real growth depending on the fiscal measure
[Afonso and Jalles, 2014, 2015]
6A. Afonso
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CAPB shocks
a) Giavazzi, Pagano (1996) b) Alesina, Ardagna (1998) c) Afonso (2010)
-0.01
-0.005
0
0.005
0.01
0.015
0.02
0.025
0.03
0 1 2 3 4 5
estimate lower limit upper limit
-0.01
-0.005
0
0.005
0.01
0.015
0.02
0.025
0.03
0 1 2 3 4 5
estimate lower limit upper limit
-0.015
-0.01
-0.005
0
0.005
0.01
0.015
0.02
0.025
0.03
0 1 2 3 4 5
estimate lower limit upper limit
Action-based data shocks
Source: Afonso, and Jalles (2015).
Response of GDP to Fiscal Consolidations
-0.012
-0.01
-0.008
-0.006
-0.004
-0.002
0
0.002
0.004
0.006
0 1 2 3 4 5
estimate lower limit upper limit
Co
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7
7. It would be useful to know what is the share of
observations in the so-called “fiscal stress” and “no
stress” regimes.
8. One can also wonder about monetary conditions,
since different degrees of monetary activism are
probably present in the sample, which may interact
differently with the fiscal retrenchment and its
potential effect on the yield spreads (the paper only
distinguishes between Monetary Union Members).
9. For instance, Afonso and Martins (2015) report that
when fiscal consolidations are coupled with
monetary expansions, the traditional Keynesian
signals are reversed in the cases of general
government final consumption expenditure.8
A. Afonso
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10. In the sensitive analysis section, the paper reports
that the debt-to-GDP ratio increases following a
fiscal retrenchment, which is not an obvious
outcome.
11.The split between euro area crisis countries and
non-crisis countries delivers rather similar results,
with yield spreads always increasing after a
government consumption cut. This is less obvious: a
split between core and periphery with PCA shows
different spread behaviour (Afonso, Arghyrou,
Kontonikas, 2014).
9A. Afonso
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10A. Afonso
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Source: Afonso, Arghyrou, Kontonikas (2014).
-6
-4
-2
0
2
4
6
8
10
99 00 01 02 03 04 05 06 07 08 09 10
First principal component
Second principal component
DecouplingCore: Finland, the Netherlands, Austria, France, Belgium. Periphery:
Greece, Portugal, Spain, Ireland, Italy [1999:01-2011:01 ]
Principal components of 10-year government bond yield spreads
12. “For the governmentspending multiplier weassume e=0.7, a value,as discussed above, inline with the estimatesreported in theliterature.” The averagegovernment spendingmultiplier can howeverbe somewhat closer to1?
11A. Afonso
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Source: Kilponen, et al. (2015).
12A. Afonso
• Afonso, A., Arghyrou, M., Kontonikas, A. (2014). “Pricing sovereign bond risk
in the EMU area: an empirical investigation”, International Journal of Finance
and Economics, 19 (1), 49–56.
• Afonso, A., and Jalles, J. (2014). “Assessing Fiscal Episodes,” Economic
Modeling, 37, 255–70.
• Afonso, A., Jalles, J. (2015). “Fiscal Episodes, Technological Progress and
Market Power”, Department of Economics, ISEG-UL, WP 09/2015/DE/UECE.
• Afonso, A., Martins, L. (2015). “Monetary Developments and Expansionary
Fiscal Consolidations: Evidence from the EMU”, International Journal of
Finance and Economics, forthcoming.
• Afonso, A., Rault, C. (2015). “Short and Long-run Behaviour of Long-term
Sovereign Bond Yields”, Applied Economics, 47 (37), 3971-3993.
• Kilponen, J., Pisani, M., Schmidt, S., Corbo, V., Hledik, T., Hollmayr, J.,
Hurtado, J., Júlio, P., Kulikov, D., Lemoine, M., Lozej, M., Lundvall, H., Maria,
J., Micallef, B., Papageorgiou, D., Rysanek, J., Sideris, D., Thomas, C., de
Walque, G. (2015). “Comparing fiscal multipliers across models and countries
in Europe”. ECB WP 1760.
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