Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2000:2: The 'Expansionary Fiscal Contraction Hypothesis' and Uncertainty About the Permanence of Fiscal Consolidations

Michael Bergman ()
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Michael Bergman: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: This paper contrasts the effects of balanced-budget reductions in government consumption on private consumption in the permanent income model and a model allowing for precautionary savings. We compare impulse responses of private consumption to temporary and permanent shocks to government consumption when agents do not observe the shocks directly or can distinguish between temporary and permanent shocks. Our simulations suggest that uncertainty about the permanence of government consumption reductions affect both the impact and the duration of private consumption whereas precautionary saving motives only affect the impact.

Keywords: Expansionary fiscal contraction; fiscal consolidations; uncertainty; precautionary savings

JEL-codes: E21; E62

21 pages, March 6, 2000

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