This paper studies the relationship between austerity intensity and adjustment processes in the Eurozone in the period 2000–2021. We empirically analyse fiscal consolidation and its impact on a set of internal adjustment and expansionary austerity indicators. We also evaluate the relationship of those indicators with GDP growth using quantile regressions. Results show that austerity programmes had a negative impact on growth both in the short-run and in the long-run. Expansionary austerity indicators play a more relevant role in determining short-term growth than internal adjustment. This effect is more intense in slow-growing countries since internal adjustment processes take more time to operate.
Policy Recommendations
- Internal devaluation processes should be accompanied by policies designed to alleviate its economic and social effects. However, the current lack of fiscal space in many European countries, as well as inflation pressures, limit the scope for this policy strategy. Fiscal and monetary policies could be considered as a complement for internal devaluations only if supply-side inflation moderates and sovereign debt pressures remain relatively subdued. This is particularly relevant for peripheral countries where internal adjustment processes take more time to operate.
- External surpluses are key for peripheral countries' growth perspectives. We propose the combination of two policy alternatives to achieve this goal. First, a stronger domestic demand in core European countries would help to maintain current account surpluses in non-core countries. Second, a decrease in labour costs should reduce demand for imports and prices in peripheral countries. This path would be more harmful in terms of short-term growth, but it would make slow-growing countries more competitive in the long-term. Both policy alternatives would be benefited by the recovery of international trade to pre-pandemic and pre-Ukraine's invasion levels.
- Austerity programmes have a negative impact on consumption, investment, and growth in the short-term. European policy makers should reduce the cost of internal adjustments through an adequate institutional framework and better counter-cyclical economic measures.
- Stronger credit control mechanisms are necessary to prevent excessive credit growth, which in the pre-financial crisis period translated into an increase in unit labour costs, appreciated real exchange rates, and deep current account deficits. Appropriate fragmentation credit measures are necessary to help small and medium enterprises' financing.
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