NO. 163. THE EFFECTS OF AUSTERITY ON FISCAL PRUDENCE: THE ROLE OF PRIVATE INDEBTEDESS AND PRIVATE INVESTMENT

Ch. Chrysanthakopoulos 2026.

Using a newly constructed narrative dataset of fiscal adjustments for 17 advanced and 12 developing economies from 1980 to 2020, this paper investigates the effectiveness of fiscal consolidations in reducing public debt and how their outcomes depend on the level of private indebtedness and private investment, using state-dependent local projection methods. I find that a 1% of GDP fiscal adjustment translates to a reduction in public debt by 2.76% over the medium term, with the effects varying across economic contexts.

Consolidations are more effective in economies with low private debt or high private investment, whereas high private indebtedness or weak investment conditions limit or even reverse the effect. Initial fiscal positions, sovereign default risk, and central bank independence further shape outcomes, with stronger debt reductions observed in low-debt, high-risk, and high-independence states. The composition of fiscal adjustments also matters, as spending-based adjustments reduce public debt more effectively than tax-based adjustments.

These results underscore the importance of accounting for private sector dynamics and institutional factors when designing fiscal consolidation strategies.

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