Public debt dynamics and austerity policies in Europe

Austerity policies embraced after 2009 in the European union have been very controversial both in political and academical debate. While its supporters claim that fiscal adjustment is necessary to restore the sustainability of public finances, critics argue that the negative effect of austerity on economic growth is so large that it may even be counterproductive. Indeed, the improvement of fiscal position and the debt to GDP ratio has been much slower and fiscal multipliers considerably larger than expected , suggesting that self-defeating austerity might be a realistic possibility. This work will examine various aspects that determine the effectiveness of fiscal policy in reducing the debt to GDP ratio, such as the initial level of debt, tax and expenditure levels, size and timing of consolidation, long run effect on economic growth. The focus will be on the sensitivity of debt to GDP projections to the underlying assumptions, to highlight the complex trade-offs of different policy options. This thesis is organized as follows: chapter 2 is devoted to the development of the general analytical framework used and its relations with previous works; in chapter 3 we will study the properties of the model through a simulation exercise under different parametrizations; in chapter 4 we will compare these results with the European countries in the period after the financial crisis. Some conclusive remarks (chapter 5) follow