TY - JOUR AU - Giavazzi,Francesco AU - Pagano,Marco TI - Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries JF - National Bureau of Economic Research Working Paper Series VL - No. 3372 PY - 1990 Y2 - May 1990 UR - http://www.nber.org/papers/w3372 L1 - http://www.nber.org/papers/w3372.pdf N1 - Author contact info: Francesco Giavazzi Universita' Bocconi and IGIER Via Guglielmo Rontgen, 1 Milan 20136 ITALY Tel: 0039-02-5836-3304 Fax: 0039-02-5836-3302 E-Mail: francesco.giavazzi@unibocconi.it Marco Pagano Department of Economics University of Naples Federico II Via Cintia, Monte S. Angelo 80126 Napoli, ITALY Tel: +390815752508 Fax: +390815752243 E-Mail: mrpagano@tin.it M1 - published as Francesco Giavazzi, Marco Pagano. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," in Olivier Jean Blanchard and Stanley Fischer, editors, "NBER Macroeconomics Annual 1990, Volume 5" MIT Press (1990) AB - 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. ER -