BPEA | Spring 2019

Fiscal space and the aftermath of financial crises: How it matters and why

Skyscrapers Shanghai Tower (L), Jin Mao Tower (Top) and Shanghai World Financial Center are seen during a hazy day at the financial district of Pudong in Shanghai, China March 20, 2017. REUTERS/Aly Song - RC1CFB242650
Editor's note:

This paper is part of the Spring 2019 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellow and Northwestern University Professor of Economics Janice Eberly and Brookings Nonresident Senior Fellow and Harvard University Professor of Economics James Stock. Read summaries of all six papers from the journal here.


In OECD countries over the period 1980–2017, countries with lower debt-to-GDP ratios responded to financial distress with much more expansionary fiscal policy and suffered much less severe aftermaths. Two lines of evidence together suggest that the relationship between the debt ratio and the policy response is driven partly by problems with sovereign market access, but even more so by the choices of domestic and international policymakers. First, although there is some relationship between more direct measures of market access and the fiscal response to distress, incorporating the direct measures attenuates the link between the debt ratio and the policy response only slightly. Second, contemporaneous accounts of the policymaking process in episodes of major financial distress show a number of cases where shifts to austerity were driven by problems with market access, but at least as many where the shifts resulted from policymakers’ choices despite an absence of difficulties with market access. These results point to a twofold message: conducting policy in normal times to maintain fiscal space provides valuable insurance in the event of financial crises, and domestic and international policymakers should not let debt ratios determine the response to crises unnecessarily.


Romer, Christina D., and David H. Romer. 2019. “Fiscal Space and the Aftermath of Financial Crises: How It Matters and Why.” Brookings Papers on Economic Activity, Spring, 239-331.


Christina Romer is the Class of 1957 Garff B. Wilson Professor of Economics at the University of California, Berkeley and a former Chair of the Council of Economic Adviser. David Romer is the Herman Royer Professor in Political Economy at the University of California, Berkeley. Beyond these affiliations, the authors did not receive financial support from any firm or person for this paper or from any firm or person with a financial or political interest in this paper. They are currently not officers, directors, or board members of any organization with an interest in this paper. No outside party had the right to review this paper before circulation. The views expressed in this paper are those of the authors, and do not necessarily reflect those of the University of California, Berkeley.