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I am writing a paper on European poverty and I am using a treatment control setup similar to Difference-in-Difference methods. Now, since the data I am using is rather recent, I would like to condition on "austerity levels", i.e. I would like to make sure that countries in the control group and those in the treatment group are equal in terms of austerity that has been employed.

This is what I have so far:

First of all I defined austerity as umbrella term for the following:

  • Public wage and employment cuts
  • Cuts in welfare expenditure
  • Rescaling labour protection institutions
  • Changes in pension age
  • Cutting the minimum wage
  • Ad-hoc tax rises

First, I thought about using GDP change as a measure. Oviously, there might be a host of other reasons why GDP changes, especially when there has just been (or there still is) a large economic downturn (defined by declining GDP).

Then, I thought of social welfare spending as an indicator. However, welfare spending might also (and indeed does) increase in times of crisis, because more people might become unemployed and need support, even though the individual height of the help has decreased. Moreover, different countries might have chosen completely different approaches to austerity. E.g. Italy has chosen to increase the tax burden, to change the pensionary system and to fight inefficiencies in taxation and government, while Latvia has primarily chosen to cut down public salaries (sometimes by 50%), while Greece seems to try both desperately. That means that it is not so clear that austerity always reflects the same way and especially that social welfare spending is a bad proxy.

Thirdly, I thought of the height of government debt as a proxy, the logic being: countries which are highly indebted might be forced to cut down on the welfare state. Again, this is a rather weak predictor for austerity, simply looking at some examples: Latvia, with a public debt of 40% of GDP in 2012 had to go through a multilateral bailout, while Germany, with a public debt of about 80% was involved in many bailouts in the recent years.

What I came up with in the end is the following: the 10 year government bond interest rates show how much confidence financial markets have in the country in question, moreover high interest rates simply force the country to save, in order to stand a realistic chance of being able to service the debt in future. Therefore, conditioning on the 10-year government bond interest rate should be able to control for at least some of the austerity effects.

My problem is that I didn't find many recent year studies using a treatment control approach for aggregated data, and even less which would describe the choice of the right austerity indicator and I am not really trusting my logic. It seems like I am missing something or that I am making life somewhat too easy.

I would be really interested in hearing your thoughts and your critique, or in the best case someone knows a well-established austerity indicator. Thank you in advance!

Best wishes

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  • $\begingroup$ Perhaps you first need to decide what you mean by "austerity" in this context. Without a firm definition, you won't be able to find a meaningful indicator. You might find that "austerity" isn't what you're asking about at all. $\endgroup$ – EnergyNumbers Dec 5 '15 at 14:15
  • $\begingroup$ Good point. I provided my definition for austerity as well. $\endgroup$ – Melograno Dec 5 '15 at 14:27
  • $\begingroup$ This paper sounds really sketchy. Here are some issues: 1) " the 10 year government bond interest rates show how much confidence financial markets have in the country in question," -NO this is completely false. CDS may be better proxies but still not close to true sovereign risk indicator. 2)"moreover high interest rates simply force the country to save" FALSE- need to look at real rate with expected inflation 3) You forget monetary and fiscal policy are linked. Austerity in a highly accommodative monetary regime is not austerity economically (maybe politically) $\endgroup$ – Stuart Allan Dec 5 '15 at 14:33
  • $\begingroup$ Thanks. It looks sketchy since I tried to isolate the problem I am having and did not want to overload the question with details. 1) Ok, that was sloppy from my part. 2) Real rate of what exactly? So would you suggest to leave the indicator (10y-ir) out completely? What could a direction in which I could continue searching be? Would you say that looking for an indicator whose change is associated with the need to implement discretionary austerity measures is a valid approach? $\endgroup$ – Melograno Dec 5 '15 at 14:59
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If it is about European Union, it would make sense to look at austerity as a response to the debt crisis. I would measure austerity not as the level of government debt, but as the change in levels of government debt from year to year. The slower the government debt (as a share of GDP) increases, the more austere are the budget policies of that country.

Also, if you have access to state budget deficits data, it would be a very convincing measure of austerity in my opinion. The less is the budget deficit, the more austere is the budget policy.

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  • $\begingroup$ Thank you very much. Still, with the change rates I have the problem of endogeneity. It might well be that in some cases a slowly increasing deficit reflects an austere policy, but I would say that holds for the long term. Harsh, short-term discretionary austerity measures might also be associated with very high increase rates. link Here, Lithuania's debt ratio increases to 146% from ~60%(!). Similar story for Ireland. Moreover, a low increase rate could also reflect that the country simply did not need austerity measures. $\endgroup$ – Melograno Dec 5 '15 at 14:20
  • $\begingroup$ Perhaps the primary balance is a more suitable measure then change in government debt since it excludes changes due to interest-rates. $\endgroup$ – Stinky Dec 5 '15 at 15:49

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