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

In: NBER Macroeconomics Annual 1990, Volume 5

  • Francesco Giavazzi
  • Marco Pagano

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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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, October.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10973.
    Handle: RePEc:nbr:nberch:10973
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.orgEmail:


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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. Alberto Alesina & Allan Drazen, 1989. "Why are Stabilizations Delayed?," NBER Working Papers 3053, National Bureau of Economic Research, Inc.
    3. 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.
    4. 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.
    5. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
    6. Francesco Giavazzi & Marco Pagano, 1989. "Confidence Crises and Public Debt Management," Working Papers 73, Dipartimento Scienze Economiche, Universita' di Bologna.
    7. 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.
    8. Robert J. Barro, 1980. "Output Effects of Government Purchases," NBER Working Papers 0432, National Bureau of Economic Research, Inc.
    9. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
    10. Feldstein, Martin, 1982. "Government deficits and aggregate demand," Journal of Monetary Economics, Elsevier, vol. 9(1), pages 1-20.
    11. Jappelli, Tullio & Pagano, Marco, 1988. "Consumption and Capital Market Imperfection: An International Comparison," CEPR Discussion Papers 244, C.E.P.R. Discussion Papers.
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