When do Fiscal Consolidations Lead to Consumption Booms? Lessons from a Laboratory Experiment

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 consolidations 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.