Scandinavian Working Papers in Economics

Working Papers,
National Institute of Economic Research

No 92: When Are Fiscal Contractions Successful? Lessons for Countries Within and Outside the EMU

Göran Hjelm ()
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Göran Hjelm: National Institute of Economic Research, Postal: National Institute of Economic Research, P.O. Box 3116, SE-103 62 Stockholm, Sweden

Abstract: In the past 25 years, many OECD countries have implemented fiscal contractions to strengthen their public finances. The macroeconomic outcomes of these efforts have varied. With the aid of an econometric model, this paper seeks to identify the factors that make contractions successful from a macroeconomic standpoint. The findings suggest, among other things, that favorable changes in the real exchange rate prior to the period of fiscal contraction and in the real quantity of money during this period play an important part in the macroeconomic outcome. This indicates in turn that it may be more difficult to implement successful fiscal contractions within the EMU. The findings also show that the composition of the contraction in regard to the relative proportions of tax increases and expenditure cutbacks, respectively, is probably less important than has usually been assumed.

Keywords: Fiscal Contractions; Fiscal Policy; Real Exchange Rate; EMU

JEL-codes: C20; E62; E63; H30

27 pages, June 16, 2004

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