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Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3372.

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Date of creation: May 1990
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Publication status: published as Francesco Giavazzi, Marco Pagano. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," in Olivier Jean Blanchard and Stanley Fischer, editors, "NBER Macroeconomics Annual 1990, Volume 5" MIT Press (1990)
Handle: RePEc:nbr:nberwo:3372

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  1. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
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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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