Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries
AbstractAccording 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 InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3372.
Date of creation: May 1990
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Publication status: published as NBER Macroeconomic Annual 1990. Cambridge, MA: MIT Press.
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Other versions of this item:
- Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 75-122 National Bureau of Economic Research, Inc.
- Giavazzi, Francesco & Pagano, Marco, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," CEPR Discussion Papers 417, C.E.P.R. Discussion Papers.
- Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of two Small Euopean Countries," Working Papers 89, Dipartimento Scienze Economiche, Universita' di Bologna.
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