Oscar Jorda and Alan Taylor: When is the time for austerity?: Noted for August 16, 2013

Oscar Jorda and Alan Taylor: When is the time for austerity?:

In recent times austerity has been systematically applied in weak economic conditions: plus ça change. But in a bad current state the economy is more likely to grow faster than trend going forward. By failing to allow for the endogeneity of treatment we could end up with a far too rosy view of the aftermath of fiscal consolidations. A dead cat bounces, regardless of whether it jumped or was pushed. Using ordinary-least-squares estimation we would walk away believing in expansionary austerity, or no effect when the economy is weak. Using 'narrative' instrument variables we might believe in contractionary austerity except when the economy is strong, but the estimates are possibly biased as the instruments may not be valid as allocation into treatment is not random. Using our two-stage method to deal with allocation bias, we find stronger evidence of contractionary austerity in the weak economy with much more precise estimates. These results suggest that only a strong economy can bear a fiscal consolidation without significant output losses…. Keynes is still right, after all: “The boom, not the slump, is the right time for austerity at the Treasury.”