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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 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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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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  1. Alberto Alesina & Allan Drazen, 1989. "Why are Stabilizations Delayed?," NBER Working Papers 3053, National Bureau of Economic Research, Inc.
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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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