Growth, Deficits and Uncertainty in a Panel of 28 Countries

We examine the relationship between fiscal deficits and per-capita income growth in a panel of 28 European countries, allowing for perceived risks, in terms of fiscal sustainability, associated with additional government spending. Such risks are proxied by the conditional variability of manufacturing production and stock market returns and by the unconditional variability of two survey-based economic-sentiment indicators. We find evidence of an asymmetric relationship, in that fiscal deficits give rise to adverse growth effects if they coincide with high uncertainty regarding the future prospects of the economy and no significant negative growth effects in the low-uncertainty case.