TY - JOUR

T1 - Expansionary fiscal contractions

T2 - Re-evaluating the Danish case

AU - Bergman, Ulf Michael

AU - Hutchison, Michael

N1 - JEL classifications: E21, E62, E65

PY - 2010

Y1 - 2010

N2 - The Expansionary Fiscal Contraction (EFC) hypothesis predicts that a major fiscal consolidation leads to an economic expansion under certain circumstances. We test this hypothesis, and the implied non-linear responses of the economy to large and small changes in fiscal policy, using data from the 1983 Danish fiscal reform. We use a structural VAR/event study methodology following Blanchard and Perotti (2002) that explicitly allows us to distinguish between normally marginal changes in fiscal policy and comprehensive fiscal reforms. We find that 'marginal changes' in fiscal policy (expenditure and tax changes) have the expected Keynesian effects on output and consumption. However, we find no evidence that the large fiscal consolidation in Denmark slowed the economy after controlling for a host of exogenous shocks and business cycle effects. Rather, we find some support for the hypothesis that the exogenous fiscal contraction in Denmark was a credible regime shift and, together with other reforms undertaken at the time, increased both private consumption and aggregate output.

AB - The Expansionary Fiscal Contraction (EFC) hypothesis predicts that a major fiscal consolidation leads to an economic expansion under certain circumstances. We test this hypothesis, and the implied non-linear responses of the economy to large and small changes in fiscal policy, using data from the 1983 Danish fiscal reform. We use a structural VAR/event study methodology following Blanchard and Perotti (2002) that explicitly allows us to distinguish between normally marginal changes in fiscal policy and comprehensive fiscal reforms. We find that 'marginal changes' in fiscal policy (expenditure and tax changes) have the expected Keynesian effects on output and consumption. However, we find no evidence that the large fiscal consolidation in Denmark slowed the economy after controlling for a host of exogenous shocks and business cycle effects. Rather, we find some support for the hypothesis that the exogenous fiscal contraction in Denmark was a credible regime shift and, together with other reforms undertaken at the time, increased both private consumption and aggregate output.

KW - Faculty of Social Sciences

KW - structural VAR

KW - event study

KW - non-linearities

U2 - 10.1080/10168731003589857

DO - 10.1080/10168731003589857

M3 - Journal article

VL - 24

SP - 71

EP - 93

JO - International Economic Journal

JF - International Economic Journal

SN - 1016-8737

IS - 1

ER -