Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/106146
Title: 
Authors: 
Dellas, Harris
Niepelt, Dirk
Year of Publication: 
2014
Series/Report no.: 
SAFE Working Paper Series 78
Abstract: 
We shed light on the function, properties and optimal size of austerity using the standard sovereign model augmented to include incomplete information about credit risk. Austerity is defined as the shortfall of consumption from the level desired by a country and supported by its repayment capacity. We find that austerity serves as a tool for securing a more favorable loan package; that it is associated with over-investment even when investment does not create collateral; and that low risk borrowers may favor more to less severe austerity. These findings imply that the amount of fresh funds obtained by a sovereign is not a reliable measure of austerity suffered; and that austerity may actually be associated with higher growth. Our analysis accommodates costly signalling for gaining credibility and also assigns a novel role to spending multipliers in the determination of optimal austerity.
Subjects: 
austerity
credit rationing
default
growth
incomplete information
investment
pooling equilibrium
separating equilibrium
JEL: 
F34
H63
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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