Fiscal tightening and markets

The Economist looks into the effect of austerity measures on market expectations and short-run growth. The publication cites research done by Carlo Cottarelli and Laura Jaramillo of the IMF.

The authors analyzed the determinants of 5-year CDS spreads for 31 advanced economies and found that markets were especially concerned about short-term variables, such as the primary balance and debt ratios, purchases of government paper by central banks, inflation and real GDP growth in 2011.

Cottarelli and Jaramillo particularly focus on whether drastic deficit cuts can lead to wider spreads, thus potentially increasing the cost of debt service. They do not argue against austerity, but rather stress the importance of combining fiscal tightening with growth friendly policies.