The Unassuming Economist

From a new paper by Antonio Fatas:

“This paper studies the negative loop created by the interaction between pessimistic estimates of potential output and the effects of fiscal policy during the 2008-2014 period in Europe. The crisis of 2008 created an overly pessimistic view on potential output among policy makers that led to a large adjustment in fiscal policy during the years that followed. Contractionary fiscal policy, via hysteresis effects, caused a reduction in potential output that not only validated the original pessimistic forecasts, but also led to a second round of fiscal consolidation. This succession of contractionary fiscal policies was likely self-defeating for many European countries. The negative effects on GDP caused more damage to the sustainability of debt than the benefits of the budgetary adjustments. The paper concludes by discussing alternative frameworks for fiscal policy that could potentially avoid this negative loop in future crises.”