Of Fairies and Governments: An ABM Evaluation of the Expansionary Austerity Hypothesis

Paradoxically, the expansionary austerity hypothesis may find greater support in a theoretical framework that places an emphasis on the role of uncertainty for investment decisions not subject to a savings-in-advance constraint than in a more standard supply-led macroeconomic theory. This paper builds a demand-driven agent-based model featuring contagion across firms to explore whether fiscal consolidations may become expansionary due to a positive effect on investors’ expectations, which could be the result of a dominant public discourse on the need for austerity. Simulations suggest that while a wave of optimism affecting a small proportion of firms may lead to short-run positive output effects in the economy, these effects are not sufficient to neutralize the negative macroeconomic impacts of cutting government spending. These findings are in keeping with the scantiness (or absence) of empirical evidence in favor of the expansionary fiscal contraction hypothesis.