Austerity and credibility in the Eurozone

During the euro crisis policy-makers tried to re-establish credibility with austere budgets. Studies of austerity have been plagued by measurement and endogeneity problems. We provide a direct test of the effect of austerity on confidence by calculating the immediate impact of austere budgets on gov...

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Bibliographic Details
Published in:European Union politics 2015-03, Vol.16 (1), p.45-66
Main Authors: McMenamin, Iain, Breen, Michael, Muñoz-Portillo, Juan
Format: Article
Language:English
Subjects:
Austerity policy
Budgetary policy
Budgets
Debt
Euro
Europe
European monetary union
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Summary:During the euro crisis policy-makers tried to re-establish credibility with austere budgets. Studies of austerity have been plagued by measurement and endogeneity problems. We provide a direct test of the effect of austerity on confidence by calculating the immediate impact of austere budgets on government bonds. We build a unique database of budget dates and conduct event studies of 223 (future) Eurozone budgets. Since austere budgets are enacted in particular circumstances, we use a treatment effects design to measure markets’ responses. Our findings are discouraging for the argument that austerity can provide a positive credibility shock. Markets do not welcome austerity. On the contrary, austere budgets are associated with substantial interest rate increases. These results underline how constrained governments are in debt crises.
ISSN:1465-1165
1741-2757
DOI:10.1177/1465116514553487