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Risk Aversion and Recessive Impacts of Austerity

Author

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  • Vaz de Castro, Afonso
Abstract
This paper aims to contribute for the vast literature on the impact of country-specific characteristics on fiscal multipliers. We argue that countries have relevant differences in risk attitudes, and that those differences are economically significant in determining output responses to fiscal consolidation programs. We start with an empirical analysis, estimating the coefficient of relative risk aversion for nine European economies, finding relevant heterogeneity across countries. Using the coefficients found, we calibrate an incomplete markets overlapping generations model and study the impacts of an unanticipated fiscal consolidation shock. We find a positive relationship between fiscal multipliers and risk aversion when there is a spending-based consolidation, showing that recessive impacts from austerity are stronger the larger the degree of risk aversion. The underlying mechanism depends on the effect of risk aversion on precautionary savings behavior and so on the share of constrained agents. Larger risk aversion induces more precautionary savings, thus shrinking the share of constrained agents. Credit-constrained agents have a less responsive labor supply with respect to spending-based fiscal consolidation shocks.

Suggested Citation

  • Vaz de Castro, Afonso, 2022. "Risk Aversion and Recessive Impacts of Austerity," MPRA Paper 111875, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:111875
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    References listed on IDEAS

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    More about this item

    Keywords

    Fiscal Multipliers; Fiscal Consolidation; Relative Risk Aversion;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being

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