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Non-linear Effects of Fiscal Policy in Germany: A Markov-Switching Approach

  • Florian Höppner
  • Katrin Wesche

Keynesian theory suggests that a reduction in government expenditure has a negative effect on private demand and therefore on output. Contrary, neoclassical theory argues that reduced public expenditure makes room for an expansion of the private sector and thus has a stimulating effect on the economy. Additionally, expectations of a lower tax burden in the future should stimulate consumption. The recent literature discusses that both theories might be right at different times. Especially, during times of fiscal contractions from high levels of debt the economy might react in a neoclassical way. In this paper, we test for non-linear effects of fiscal policy in a Markov-switching approach. We find two different regimes, with a neoclassical regime prevailing around 1972-74, 1979-82 and 1991-93. Furthermore, using time-varying transition probabilities (TVTP) for the Markov process, we test if the neoclassical reaction of private consumption to fiscal variables depends on some!

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Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse9_2000.

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Length: 25 pages
Date of creation: Jul 2000
Date of revision:
Handle: RePEc:bon:bonedp:bgse9_2000
Contact details of provider: Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
Fax: +49 228 73 6884
Web page: http://www.bgse.uni-bonn.de

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