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Expansionary Austerity and Reverse Causality

Breuer, Christian (2017): Expansionary Austerity and Reverse Causality.

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We show that the cyclical adjustment strategy used in a large stream of literature on the conventional or data-based analysis of fiscal policy fails to correct for cyclical effects in the case of expenditure-GDP-ratios so that the finding of expansionary austerity in this literature is based on reverse causality, i.e. increasing GDP causally decreases expenditure-GDP-ratios and not vice versa. Proposing a new version of the “Blanchard”-method of cyclical adjustment, correcting for this error, and replicating Alesina and Ardagna (2010), the expansionary effects of fiscal consolidations disappear or turn into opposite. These findings may help understanding some of the controversies in the recent literature and contribute to a rehabilitation of the conventional approach and the “Blanchard method” to compute cyclically-adjusted government budget data.

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