Why \u27Fiscal Austerity\u27? A Review of Recent Evidence on the Economic Effects of Sovereign Debt

Concerns about the economic effect of high sovereign debt levels have motivated policy makers to constrain or reduce the growth of fiscal deficits, a practice commonly known now as fiscal austerity. However, what do we know about the economic impacts of sovereign debt? This article provides an overview of some recent empirical economic research into this question. The article first discusses data and estimation challenges confronted by empirical research into the impact of sovereign debt on economic growth. The article then reviews several studies, which vary by country sample, time period studied, and estimation technique employed. The article also reviews recent empirical studies of the economic consequences of sovereign default. The results of this article\u27s survey suggest that while the bulk of the evidence shows a negative relationship between sovereign debt levels and economic growth, the evidence to date is mixed on whether higher debt burdens cause or are merely correlated with lower economic growth, and on whether there exists a certain \u27threshold\u27 beyond which this negative relationship arises. Only a few studies have provided evidence on the economic mechanism through which higher debt burdens impact economic growth. This review of the research does, however, reveal stronger evidence that sovereign default episodes have negative impacts on an economy\u27s growth. The article concludes by raising some important questions to be addressed if we are to better understand the economic impacts of debt