Long-Term Effects of Fiscal Stimulus and Austerity in Europe

Executive Summary

Fiscal policy during Europe’s post-crisis consolidation had lasting effects on growth. Covering around twenty European economies, this study analyses fiscal shocks between 2010 and 2011 and their impact on potential output over the following five years. Using a narratively identified measure of fiscal stance — the discretionary fiscal effort (DFE) — it provides robust evidence that both stimulus and austerity left persistent marks on Europe’s productive capacity.

Fiscal multipliers were strongly and persistently underestimated. Official forecasts by the IMF and European Commission assumed small and short-lived effects, typically around 0.5. In reality, the study finds that actual multipliers averaged about 1.3 and remained significant even five years after implementation. Fiscal policy, in short, has durable consequences for potential output and long-term growth.

Austerity deepened and prolonged the crisis. The fiscal consolidations introduced in 2010–2011, when demand was already weak and interest rates near zero, were badly timed. Instead of restoring confidence, they depressed investment, slowed capital accumulation, and caused permanent output losses through hysteresis effects.

Stimulus delivered long-term gains in potential output. Expansionary measures, by contrast, raised output persistently, especially when driven by higher spending rather than tax cuts. Stimulus not only supported short-term recovery but also strengthened the economy’s underlying growth path.

Effects weakened after 2013. As Europe recovered, fiscal multipliers declined and policy effects became less persistent, confirming that fiscal actions have their greatest impact during recessions and at the zero lower bound.

The lesson for Europe’s fiscal governance is clear. Fiscal policy should not be assessed only through short-term GDP or debt effects. Its composition, timing, and persistence determine the sustainability of public finances and the resilience of European economies.

Policy Recommendations

1. Integrate long-term multiplier effects into EU fiscal rules and debt sustainability analyses to capture structural impacts on growth.

2. Avoid premature fiscal consolidation during downturns to prevent hysteresis and lasting output losses.

3. Favour spending-based stimulus over tax cuts, given its stronger and more durable growth effects.

4. Treat fiscal policy as a long-term instrument for stabilisation and resilience, not merely a short-term countercyclical tool.