The Effect of Unconventional Fiscal Policy on Consumption Expenditure
76 Pages Posted: 31 Aug 2016
Date Written: August 2016
Unconventional fiscal policy uses announcements of future increases in consumption taxes to generate inflation expectations and accelerate consumption expenditure. It is budget neutral and time consistent. We exploit a unique natural experiment for an empirical test of the effectiveness of unconventional fiscal policy. To comply with European Union law, the German government announced in November 2005 an unexpected 3-percentage-point increase in value-added tax (VAT), effective in 2007. The shock increased households' inflation expectations during 2006 and actual inflation in 2007. Germans' willingness to purchase durables increased by 34% after the shock, compared to before and to matched households in other European countries not exposed to the VAT shock. Income, wealth effects, or intratemporal substitution cannot explain these results.
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