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Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries

In: NBER Macroeconomics Annual 1990, Volume 5

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  • Francesco Giavazzi
  • Marco Pagano

Abstract

According to conventional wisdom, a fiscal consolidation is likely to contract real aggregate demand. It has often been argued, however, that this conclusion is misleading as it neglects the role of expectations of future policy: if the fiscal consolidation is read by the private sector as a signal that the share of government spending in GDP is being permanently reduced, households will revise upwards their estimate of their permanent income, and will raise current and planned consumption. Only the empirical evidence can sort out which of these two contending views about fiscal policy is more appropriate -- i.e how often the contractionary effect of a fiscal consolidation prevails on its expansionary expectational effect. This paper brings new evidence to bear on this issue drawing on the European exercise in fiscal rectitude of the 1980s, and focusing, in particulars on its two most extreme cases -- Denmark and Ireland. We find that at least in the experience of these two countries the expectations' view has a serious claim to empirical relevance.

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This chapter was published in:

  • Olivier Jean Blanchard & Stanley Fischer, 1990. "NBER Macroeconomics Annual 1990, Volume 5," NBER Books, National Bureau of Economic Research, Inc, number blan90-1, Ekim.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10973.

    Handle: RePEc:nbr:nberch:10973

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    1. Aschauer, David Alan, 1985. "Fiscal Policy and Aggregate Demand," American Economic Review, American Economic Association, vol. 75(1), pages 117-27, March.
    2. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," NBER Working Papers 2926, National Bureau of Economic Research, Inc.
    3. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers, Tel Aviv - the Sackler Institute of Economic Studies 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
    4. Jappelli, Tullio & Pagano, Marco, 1989. "Consumption and Capital Market Imperfections: An International Comparison," American Economic Review, American Economic Association, vol. 79(5), pages 1088-1105, December.
    5. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
    6. Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(5), pages 895-916, October.
    7. Barro, Robert J., 1981. "Output Effects of Government Purchases," Scholarly Articles 3451294, Harvard University Department of Economics.
    8. Feldstein, Martin, 1982. "Government deficits and aggregate demand," Journal of Monetary Economics, Elsevier, vol. 9(1), pages 1-20.
    9. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
    10. Seater, John J. & Mariano, Roberto S., 1985. "New tests of the life cycle and tax discounting hypotheses," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 195-215, March.
    11. Ahmed, Shaghil, 1987. "Government spending, the balance of trade and the terms of trade in British history," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 195-220, September.
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    1. Reforma laboral: Aquí y Ahora
      by Samuel Bentolila in Nada Es Gratis on 2010-03-10 22:05:42
    2. Can a reduction in government spending stimulate the economy?
      by Matt Mitchell in Neighborhood Effects on 2010-11-15 17:25:01
    3. The Impact of Spending Cuts on the Economy
      by Veronique de Rugy in The Corner on 2011-02-25 14:55:00
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