When do fiscal consolidations lead to consumption booms?: Lessons from a laboratory experiment

Martin Geiger; Wolfgang J. Luhan; Johann Scharler

doi:10.1016/j.jedc.2016.05.003

When do fiscal consolidations lead to consumption booms? Lessons from a laboratory experiment

Martin Geiger, Wolfgang J. Luhan, Johann Scharler

University of Innsbruck

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Abstract

According to the expectations channel, a fiscal consolidation may give rise to less contractionary, or even expansionary effects on consumption, despite a decline in current disposable income. Intuitively, people may accumulate a stock of savings in anticipation of the consolidation and may start to reduce their savings to support consumption once it occurs. We design a laboratory experiment to study the conditions under which the expectations channel operates. Our results indicate that fiscal contractions that occur in an unsustainable fiscal environment exert less contractionary effects on consumption, which supports the expectations channel. We also find that the expectations channel is more pronounced if the fiscal authority can convincingly commit to abstain from tax increases in the future, whereas increasing subjects׳ level of awareness by running a transparent policy has only little influence on the outcomes.

Original language	English
Pages (from-to)	1-20
Journal	Journal of Economic Dynamics and Control
Volume	69
Early online date	15 May 2016
DOIs	https://doi.org/10.1016/j.jedc.2016.05.003
Publication status	Published - 16 Aug 2016

Keywords

expansionary fiscal consolidation
expectations
intertemporal choice
experimental macroeconomics

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10.1016/j.jedc.2016.05.003

LUHAN_2016_cright_JEDC_When do fiscal consolidations lead to consumption booms
NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Economic Dynamics and Control. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Dynamics and Control, 69, 2016, DOI: 10.1016/j.jedc.2016.05.003
Accepted author manuscript (Post-print), 431 KB

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title = "When do fiscal consolidations lead to consumption booms?: Lessons from a laboratory experiment",

abstract = "According to the expectations channel, a fiscal consolidation may give rise to less contractionary, or even expansionary effects on consumption, despite a decline in current disposable income. Intuitively, people may accumulate a stock of savings in anticipation of the consolidation and may start to reduce their savings to support consumption once it occurs. We design a laboratory experiment to study the conditions under which the expectations channel operates. Our results indicate that fiscal contractions that occur in an unsustainable fiscal environment exert less contractionary effects on consumption, which supports the expectations channel. We also find that the expectations channel is more pronounced if the fiscal authority can convincingly commit to abstain from tax increases in the future, whereas increasing subjects׳ level of awareness by running a transparent policy has only little influence on the outcomes.",

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AU - Scharler, Johann

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N2 - According to the expectations channel, a fiscal consolidation may give rise to less contractionary, or even expansionary effects on consumption, despite a decline in current disposable income. Intuitively, people may accumulate a stock of savings in anticipation of the consolidation and may start to reduce their savings to support consumption once it occurs. We design a laboratory experiment to study the conditions under which the expectations channel operates. Our results indicate that fiscal contractions that occur in an unsustainable fiscal environment exert less contractionary effects on consumption, which supports the expectations channel. We also find that the expectations channel is more pronounced if the fiscal authority can convincingly commit to abstain from tax increases in the future, whereas increasing subjects׳ level of awareness by running a transparent policy has only little influence on the outcomes.

AB - According to the expectations channel, a fiscal consolidation may give rise to less contractionary, or even expansionary effects on consumption, despite a decline in current disposable income. Intuitively, people may accumulate a stock of savings in anticipation of the consolidation and may start to reduce their savings to support consumption once it occurs. We design a laboratory experiment to study the conditions under which the expectations channel operates. Our results indicate that fiscal contractions that occur in an unsustainable fiscal environment exert less contractionary effects on consumption, which supports the expectations channel. We also find that the expectations channel is more pronounced if the fiscal authority can convincingly commit to abstain from tax increases in the future, whereas increasing subjects׳ level of awareness by running a transparent policy has only little influence on the outcomes.

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KW - intertemporal choice

KW - experimental macroeconomics

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JO - Journal of Economic Dynamics and Control

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When do fiscal consolidations lead to consumption booms? Lessons from a laboratory experiment

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Keywords

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