Asset Values and Policy Changes : The Case of Denmark

At the end of 1982 Denmark implemented a fiscal stabilization program which led to an economic expansion. This expansionary effect, as Giavazzi and Pagano (1990) and Bertola and Drazen (1993) argue, should be expected if consumers are forward- looking and the stabilization program is anticipated. This paper asks whether a similar model of forward-looking consumers is also capable of explaining the behavior of asset prices around the time of the stabilization. We argue that the behavior of Danish financial markets points in the direction of two interesting features of the policy change. First, in a model of intertemporal consumption smoothing, the observed stock market rally suggests that investors expected an increase in after-tax dividends. The term-structure evidence, on the other hand, is consistent with less than full credibility of the retrenchment, that is with investors attaching some probability to a further expansion of the government sector