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Can Severe Fiscal Contractions Be Expansionary? Tales of two Small Euopean Countries

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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 distinguish which view is the more appropriate, that is, how often the contractionary effect of a fiscal consolidation prevails over its expansionary expectational effect. This paper presents new evidence, drawing on the European exercise in fiscal rectitude of the 1980s and focusing 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 relevan.

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Bibliographic Info

Paper provided by Dipartimento Scienze Economiche, Universita' di Bologna in its series Working Papers with number 89.

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Date of creation: Apr 1990
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Handle: RePEc:bol:bodewp:89

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References

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  1. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," Working Papers 73, Dipartimento Scienze Economiche, Universita' di Bologna.
  2. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
  3. Jappelli, Tullio & Pagano, Marco, 1988. "Consumption and Capital Market Imperfection: An International Comparison," CEPR Discussion Papers 244, C.E.P.R. Discussion Papers.
  4. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  5. Feldstein, Martin, 1982. "Government deficits and aggregate demand," Journal of Monetary Economics, Elsevier, vol. 9(1), pages 1-20.
  6. Barro, Robert J., 1981. "Output Effects of Government Purchases," Scholarly Articles 3451294, Harvard University Department of Economics.
  7. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  8. 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.
  9. 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.
  10. Aschauer, David Alan, 1985. "Fiscal Policy and Aggregate Demand," American Economic Review, American Economic Association, vol. 75(1), pages 117-27, March.
  11. Hayashi, Fumio, 1982. "The Permanent Income Hypothesis: Estimation and Testing by Instrumental Variables," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 895-916, October.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  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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