Austerity and output dynamics in the Euro Area: some evidence from a New Keynesian small open economy model

My thesis work focuses on austerity policies, that were adopted in many European countries during the sovereign debt crisis. These measures were necessary to counteract the deep increase in government debts and deficits of many countries and to remove their possibility of default. Nevertheless, the countries that started the largest set of restrictive fiscal policies, such as Greece, Spain, Ireland, Portugal and Italy, were also those who went through the worst evolution of the GDP. Thus, the purpose of my thesis is to analyze the effects of the austerity measures by describing their impact on the output growth. In particular, my investigation focuses on the policies that implied a reduction in the public expenditures with the aim to illustrate their contribution in the drop of the output of the European countries that have experienced the most severe GDP contractions. To conduct my analysis I use a standard New Keynesian small open economy model, applying it to different European countries, such as Italy, Portugal and Spain. In particular, I create a controlled experiment, where the variable of interest is inserted in the model reproduced in the software Dynare, on the basis of real data for each country. The main conclusion is that the dimension of the reduction in government spending, has played an important role in influencing the fall of GDP. Nevertheless, these effects only account for a limited part in the overall reduction of output of the countries considered in the analysis.