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

55 Pages Posted: 9 May 2000 Last revised: 20 Sep 2010

See all articles by Francesco Giavazzi

Francesco Giavazzi

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: May 1990

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.

Suggested Citation

Giavazzi, Francesco and Pagano, Marco, Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries (May 1990). NBER Working Paper No. w3372. Available at SSRN: https://ssrn.com/abstract=227984

Francesco Giavazzi (Contact Author)

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Marco Pagano

University of Naples Federico II - Department of Economics and Statistics ( email )

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Italy
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Centre for Studies in Economics and Finance (CSEF) ( email )

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Einaudi Institute for Economics and Finance (EIEF)

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Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

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Belgium

HOME PAGE: http:/www.ecgi.org

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