Expansionary Fiscal Contractions and Equilibrium Indeterminacy : A Case Study for Germany

At several occasions, the 1980's witnessed non-keynesian effects of fiscal contractions. Most notably, cuts in government spending in Ireland, Denmark and Germany are known to have coincided with increases in private consumption spending. Self-fulfilling expectations about the effects of stabilization policies may explain these and a diversity of opposing experiences. This paper formulates a real business cycle model with equilibrium indeterminacy, which allows for sunspot fluctuations as well as for systematic consumption effects of government policy in either direction. Cointegration tests and Euler equation estimates suggest that the model is approximately in accord with German data. Parameter estimates imply that the nonkeynesian experiences are not due to self-fulfilling expectations but to the productivity effects of government-provided infrastructure