Searching for Non-Monotonic
Effects of Fiscal Policy:
New EvidenceFrancesco Giavazzi, Tullio Jappelli,
Marco Pagano, and Marina Benedetti

Data revisions and the availability of a longer sample offer the opportunity to reconsider empirical findings that suggest that in the OECD
countries national saving responds non-monotonically to fiscal policy. The
paper confirms that the circumstance most likely to give rise to a nonmonotonic response of national saving to a fiscal impulse is a “large andpersistent impulse,” defined as one in which the full employment surplus,
as a percentage of potential output, changes by at least 1.5 percentage
points per year over a two-year period. This particular circumstanceremains the only statistically significant one even when we allow for
non-monotonic responses to arise when public debt is growing rapidly orinterest rate spreads are widening. We find that non-monotonic responses
are similar for fiscal contractions and expansions. In particular, an
increase in net taxes has no effect on national saving during large fiscal
contractions or expansions. For government consumption there is a large,
albeit in some specifications less than complete, offset during expansions
or contractions.
Keywords: Fiscal policy; National saving
JEL Classification: E21, E62, H31

Francesco Giavazzi: IGIER, Università Bocconi, NBER, and CEPR (E-mail: francesco.giavazzi@
unibocconi.it)
Tullio Jappelli: CSEF, Università di Salerno, and CEPR (E-mail: tullioj@tin.it)
Marco Pagano: CSEF, Università di Napoli Federico II, and CEPR (E-mail: mrpagano@tin.it)
Marina Benedetti: IGIER, Università Bocconi (E-mail: marina@benedetti.ws)
We thank our discussants for their very useful comments. Research for this paper has been partly
financed by the Italian Ministry for Universities and Scientific Research (MIUR).
MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005
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I. Introduction
The idea that fiscal consolidation can bear fruit in the short term is controversial.
Some time ago, the Financial Times described the situation thus: “In one corner wehave the political left, armed with a multiplier, and in the other we have the right,
armed with a Laffer curve. The left insists that increased public spending boosts
output via demand—the famous multiplier effect. The right asserts that tax cuts
and curbs on public spending stimulate private sector effort via supply.”
Commenting on this remark, Rodrigo de Rato, managing director of theInternational Monetary Fund (IMF), appropriately observed that the subject is much
more complicated than that: “It is true that the starting point should be the standard
Keynesian tenet that fiscal adjustment is contractionary. However, some years ago,
in a surprising departure from this orthodox stance, Giavazzi and Pagano (1990)
pointed to Denmark and Ireland in the 1980s as examples of expansionary fiscal
contractions, as their respective fiscal adjustments were followed immediately byan increase in growth. The explanation of these cases was firmly rooted in the
tradition of the turnaround in rational expectations. The argument is that a decisive
policy for reducing both the fiscal deficit and high levels of indebtedness can shore
up market confidence and create expectations among the public about future income.”1
The possibility that fiscal contractions may be a source of economic growth
immediately attracts those who doubt the effectiveness of traditional Keynesian fiscal
policies, arguing that many empirical studies have shown the limited magnitude of
fiscal multipliers, and these critics point to many instances, above all in the case ofJapan, where the response of the economy to a fiscal expansion has been weak or
nonexistent. But how common are expansionary fiscal contractions, or contractionary
expansions, and when do they occur? This question has induced many institutions,
including the IMF, the Organisation for Economic Co-operation and Development(OECD), and the European Commission (EC), to take a closer look at such episodes,
in particular of expansionary fiscal contractions.
In previous work, we search for the circumstances in which the private-sector
response to fiscal policy impulses is non-monotonic (Giavazzi and Pagano [1990,
1996], and Giavazzi, Jappelli, and Pagano [2000], hereafter referred to as GJP). The
results drawn from the experience of OECD countries show that a non-monotonic
response is more likely to arise when fiscal impulses are large and persistent and that
non-monotonic effects are larger and more precisely estimated for changes in net
taxes than for changes in public consumption.
In this paper we reconsider, extend, and update the evidence analyzed in GJP.
There are several reasons to extend and update our previous results. First of all, thedata used in GJP ended in 1996. Eight more years of data have since become available, and these include several new episodes of fiscal contractions and expansions:among them, the fiscal contractions in Europe to meet the Maastricht criteria in the
run-up to European Monetary Union (EMU) and the subsequent fiscal expansions in
2000–02; the Japanese fiscal expansion that lasted through most of the 1990s; and1. De Rato y Figaredo (2004).

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Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

the U.S. fiscal expansion during the first Bush administration. By extending thesample, we are able to increase from 109 to 128 the number of episodes characterized
by a “large and persistent fiscal impulse,” defined in GJP as one in which thefull employment surplus, as a percentage of potential output, changes by at least
1.5 percentage points per year over a two-year period. The updated sample includes
five more “large and persistent” contractions and 14 more “large and persistent”
expansions with respect to GJP.
Secondly, since GJP was written, the OECD has revised backward some of therelevant series. In particular, its measure of the cyclically adjusted primary budget
surplus has changed significantly, as the correlation between the old and the newseries between 1970 to 1996, the original sample, is 0.874. Some of the episodes oflarge and persistent fiscal impulse considered in GJP have thus disappeared from thesample, replaced by a few new ones. The series for potential output has also beenrevised, as have other variables. It is thus interesting in itself to check whether theoriginal results survive when using the revised data.
Finally, we check the robustness of the results by allowing for a different sourceof non-monotonic response of national savings to fiscal impulses: the possible roleof the risk premium on government bonds—either exchange rate risk premiumor default risk. This channel is suggested by the findings in Ardagna (2004) andby models of debt default (Blanchard [1990]) and liquidity (Caballero andKrishnamurty [2004]).
Our findings suggest, in a nutshell, that the hypothesis of a non-monotonic
response of national savings to fiscal impulses is confirmed in the updated andrevised OECD dataset. They also confirm that the circumstance most likely to giverise to a non-monotonic response of national saving is a “large and persistent fiscal
impulse,” defined as one in which the full employment surplus, as a percentage ofpotential output, changes by at least 1.5 percentage points per year over a two-year
period. On the other hand, fiscal impulses that are “relatively small” tend to be
associated with Keynesian effects.
The rest of the paper is organized as follows. We survey the relevant literature in
Section II, present the data in Section III, report the econometric estimates in
Section IV, and summarize the results in Section V.

II. What Have We Learned from the Analysis of
Large Fiscal Adjustments?
A recent study by the EC covering 14 European Union (EU) countries in the period
1970–2002 finds that roughly half of the 49 episodes of fiscal consolidation they
identify have been followed by an acceleration in growth (Giudice, Turrini, and in’t
Veld [2003]). This result is robust with respect to the criteria used to identify the
consolidation episodes and to classify such episodes as expansionary. Using the EC’smacroeconomic model (QUEST) to understand the mechanisms that could give riseto an output expansion, the study concludes that the source of non-Keynesian effects
mostly lies in the response of private consumption to expected future income.

199

Similar work at the Central Bank of Poland (Rzonca and Cizkowicz [2005]) looks
at seven episodes of strong fiscal adjustment (in this case, both expansions and contractions) that occurred since the mid-1990s in eight new EU member countries: theCzech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, andSlovenia. The paper finds evidence that discretionary fiscal consolidation “contributes
substantially to the acceleration of output growth even in the short run,” but is unable
to identify unambiguously the channels through which non-Keynesian effects occur.
The IMF has also looked at the effects of large fiscal consolidations—measured
as a cumulative primary fiscal adjustment of more than 5 percent of GDP—andconcluded that they appear to be associated quite frequently with a positive macroeconomic response (Martinez [2004]). The study covers more than 160 countries
in the last 30 years and identifies 155 episodes of large fiscal adjustment. About
40 percent of these episodes were linked to an upturn in short-term growth—although
it is once again difficult to identify the likely sources of the observed output expansion.
Work at the OECD has examined the extent to which fiscal policy actions may
be offset by simultaneous, anticipatory changes in private saving, as well as the determinants of that offset (de Mello, Kongsrud, and Price [2004]). Based on a sample
of 21 OECD countries spanning the period 1970–2002, the study finds strong
evidence of partial, yet substantial, offsetting movements in private saving. The overall offset is estimated at between about one-third and one-half, depending on model
specification, and applies both to public consumption and to shifts in tax revenue.
The magnitudes of these estimated offsets suggest that, in response to a fiscal tightening of approximately 5 percent of GDP—comparable to that of the OECD area as awhole during the upturn that occurred between 1993 and 2000—private saving is
expected to fall by about 2.5 percent of GDP over the period. The effect on nationalsaving of a fiscal easing of this magnitude is therefore of a rise of about 2.5 percent ofGDP, other things equal. The saving offset appears to be greater over the longer term,with changes in fiscal stance being almost totally offset by changes in private saving,leaving national saving largely unaffected.
As for the conditions under which such effects are more likely to occur, theOECD paper finds that (1) private saving offsets appear to have been somewhat
lower at higher levels of indebtedness; (2) the revenue/expenditure composition of
the fiscal shift matters for the private saving offset; and (3) private saving appears to
respond in relatively equal proportion to changes in current revenue and expenditure,
but public investment does not elicit an offsetting response of saving.
Investigating the response of consumers to a fiscal impulse, Giavazzi and Pagano(1996) find that private consumption appears to respond in a non-monotonic way tofiscal impulses. Their results suggest that such non-monotonic effects tend to be associated with large and persistent fiscal impulses, and appear to be stronger for fiscal
contractions than for fiscal expansions.2 While in normal times an increase in net
2. There are several explanations for such non-monotonic effects. Spending cuts or tax increases can produce anincrease in private consumption only if they raise the market value of nonhuman wealth or consumers’ perceptionof their permanent income. Changes in permanent income depend on expectations. A spending cut that is
sufficiently large and believed to be persistent can signal a future reduction in the tax burden, and therefore an
increase in permanent disposable income (a point first made in Feldstein [1982]). But even small changes in

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Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

taxes (i.e., taxes net of government transfers) tends to depress consumption, during
large fiscal contractions the effect on consumption of an increase in net taxes is notstatistically different from zero. For government spending, they find that an increase(a cut) in public spending stimulates (lowers) consumption in normal times, but
reduces (raises) it during a large fiscal impulse.
GJP also study the response of consumers to a fiscal impulse, but from a slightly
different angle, that is, looking at the effects of fiscal policy on national savings. This
allows them to interpret the results with reference to the predictions of Ricardianequivalence. As is well known, models with infinite horizons imply that (for a given
level of government spending) taxes and transfers have no effect on national saving;in other words, the Ricardian proposition holds. On the other hand, the standard
overlapping-generations model with finite horizon predicts that an increase in taxes(or a reduction in transfers) raises national saving. But the sign and size of the effectof fiscal policy on national saving might also depend on the level and sustainability of
government debt, on the size and persistence of the fiscal impulse, or on the change
in composition of the budget. In some situations (e.g., in the model described in
Blanchard [1990]) an increase in net taxes may even produce a decline in nationalsaving, by generating a boom in private consumption.
GJP search systematically for the circumstances in which national saving responds
non-monotonically to fiscal policy impulses, using two datasets, of which one includes
OECD countries and the other looks instead at emerging market economies. The
results drawn from the OECD sample show that a non-monotonic response ofnational saving is more likely to arise when fiscal impulses are large and persistentand that non-monotonic effects on national saving are larger and more precisely
estimated for changes in net taxes than for changes in public consumption.
Furthermore, non-monotonic effects also appear to be asymmetric, and stronger andmore precisely estimated for fiscal contractions than for fiscal expansions; in particular,
during large fiscal contractions an increase in net taxes has little or no effect onnational saving. They also find that a rapidly growing public debt is not, per se,a good predictor of non-monotonic responses.
These findings about the effect of the size and composition of the fiscal impulse are
not entirely consistent with those found in other studies. Alesina and Perotti (1995,
1997) and Alesina and Ardagna (1998) find that the private-sector response is larger if
the budget is cut by slashing public-sector wages and reducing social security benefits,rather than by raising taxes and cutting public investment. Along the same lines,
Ardagna (2004) finds that fiscal adjustments effected by government spending cuts andgenerating a permanent and substantial decrease in government debt are associatedwith larger reductions in interest rates and increases in stock market prices—thus
suggesting that the increase in the market value of nonhuman wealth is the channel
through which such fiscal impulses raise output growth. Perotti (1999) finds that theoutcome of a consolidation is more likely to be expansionary when public debt is highpublic spending could produce large changes in private consumption in the opposite direction if they signal achange in regime or are sufficient to bring the economy over a critical threshold, as in the model of Bertola andDrazen (1993). See Giavazzi, Jappelli, and Pagano (2000) for a review of various models that produce these results.

201

or growing rapidly, but de Mello, Kongsrud, and Price (2004), as mentioned above,report findings that are more consistent with the results shown in GJP.
Finally, the presence of credit market imperfections constraining household borrowing may also affect the non-monotonic response of saving and consumption to
fiscal policy. A non-monotonic response of private consumption and saving to a large
and persistent fiscal contraction requires well-functioning household credit markets.
Consider the case of a large increase in net taxes that leads households to update theestimate of their permanent income: if the household is prevented from borrowing
against the expectation of higher future income, it will be unable to increase its actual
spending. Ferraro (2005) tests whether the non-monotonic response of nationalsaving depends on the ease with which households can tap financial markets andborrow. He splits the sample in two, distinguishing countries based the maximum“loan-to-value ratio”—the ratio between the maximum mortgage loan that a typicalhousehold could obtain, and the value of the house for which the loan was extended(reported in Jappelli and Pagano [1994, table 1]). He finds that non-monotonic
effects are more likely to arise in countries characterized by a relatively high loan-tovalue ratio, and are smaller and less precisely estimated in countries with a relatively
lower loan-to-value ratio. This accords with the prediction that the functioningof the market for household credit affects the presence and magnitude of thenon-monotonic effects of fiscal policy.
Summarizing, while episodes of contractionary fiscal expansions, and expansionary
contractions, are a rather common finding, there is still disagreement on the conditions
under which a fiscal consolidation can raise output growth—or a fiscal expansion
can reduce it—and on the channels through which such effects might occur.
Understanding these issues is obviously essential if one wishes to know which policies
might improve the likelihood of non-Keynesian outcomes. One purpose of thepresent paper is to test the robustness of the findings which suggest that a prerequisite
for such non-Keynesian outcomes is the magnitude and persistence of the fiscal
impulse, and that the channel through which fiscal impulses affect the economy isprivate consumption.

III. A First Look at the Data
We start with a visual impression of our data. Figure 1 plots the distribution of thefirst differences in the full employment government surplus scaled by full employment
output. Positive numbers correspond to fiscal contractions, and negative numbers
to fiscal expansions. The sample and OECD countries considered are reported in
the Appendix.
Most fiscal impulses—from one year to the next—are relatively small: contractions and expansions that do not exceed 1.5 percent of potential output. But there
are many episodes outside this range, particularly in the case of fiscal expansions, andsome contractions are as large as 5 percent of potential output in a single year.
Our definition of a “large and persistent” fiscal impulse uses a subset of theepisodes in the tails of the distribution reported in Figure 1: those that lie outside

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Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

the –1.5/+1.5 percentage point range, and among them only those where a change ofat least that magnitude has occurred for at least two subsequent years. This gives us
69 episodes of “large and persistent” fiscal contraction and 51 episodes of “large andpersistent” fiscal expansion. The individual episodes are reported in the Appendix.
How were these “large and persistent” contractions and expansions implemented?
By acting on revenues, government consumption, or public investment? Table 1 compares the growth rate of net taxes (taxes net of government transfers), of government
consumption and of public investment (each defined as a fraction of potential
Figure 1 Year-to-Year Change in Full Employment Surplus
Density
0.4

0.3

0.2

0.1

0.0
–5.0

–3.0

–1.5

0.0

1.5

3.0

5.0
Percent

Note: The figures plot the change in the full employment budget surplus scaled byfull employment output. Countries included are reported on the Appendix.

Table 1 Taxes and Spending during Fiscal Contractions and Expansions,
Relative to Normal Times

T /Y *G /Y *I /Y *
Average length of a fiscal episode
Number of fiscal episodes

Fiscal contractions+1.1 percentage points–1.2 percentage points–4.0 percentage points
2.95 years
69

Fiscal expansions–5.9 percentage points+0.6 percentage point+0.6 percentage point
2.98 years
51

Note: The table reports the yearly percentage change in the ratios of taxes and spending to full employment output (T /Y * and G /Y * ) and public investment (I /Y * ) during episodes of “large and persistent”
fiscal contractions and expansions. The numbers are deviation from mean growth rate in “normal”
times. The sample period is 1964–2003. Countries included in the estimation and variables’
definitions are reported in the Appendix.

203

output) in years characterized by large contractions and large expansions, relative to“normal” times.
Fiscal expansions are typically driven by large reduction in taxes (relative to normal times) and by some growth in expenditure, both investment and consumption(also relative to normal times). But tax cuts account for the lion’s share in a fiscal
expansion. Instead, when governments slash the budget, they mostly do it by cutting
public investment. During a typical contraction, the growth rate of public investment
as a share of potential output is 4 percentage points lower than in normal times. Net
taxes increase during a contraction and government consumption falls, but by amuch smaller amount than public investment.
Figure 2 plots the change in national saving during episodes of “large and persistent” fiscal contraction (in the upper panel) and expansion (in the lower panel). The“normal” situation would be one in which a fiscal contraction raises national saving,
and a fiscal expansion reduces it. Figure 2 shows that in the majority of episodes
national saving is unaffected by the change in fiscal policy, indicating that private
saving offsets the change in public saving one for one. But there are observations
on both tails.
During episodes of large fiscal contraction (the upper panel), although the
instances in which the fiscal contraction raises national saving (along the right-handtail) are relatively more frequent, there is some mass in the left-hand tail, indicating
episodes in which the offset is more than one for one. Symmetrically, during episodesof large fiscal expansion (the lower panel) there is some mass in the right-handtail, which correspond to episodes where the private-sector offset was more thancomplete—although once again most of the fiscal expansions appear to lower
national saving (the left tail). The bottom line is that the “normal” response to large
fiscal impulses appears prima facie more frequent in the data, but there are also
instances of non-monotonic responses.

204 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

Figure 2 National Saving during Large Fiscal Contractions and Expansions[1] Change in National Saving during Large Fiscal Contractions
Density
0.4

0.3

0.2

0.1

0.0
–6

–4

–2

0

2

4

6
Percent

46Percent[2] Change in National Saving during Large Fiscal Expansions
Density
0.4

0.3

0.2

0.1

0.0
–6

–4

–2

0

2

Note: The figure plots the change in gross national saving during periods of large fiscal
contractions and expansions. Episodes of large contractions are defined as
years in which the change in the ratio of full employment surplus to potential
output is greater than 1.5 percent; large expansions are years in which thechange in full employment surplus is lower than –1.5 percent.

205

IV. Empirical Results
We estimate, as in GJP, the following reduced-form equation, whose dependent variable
is the national saving rate as a ratio to potential output:3*
S–t =  +  –––St −1 +  Y
Tt
Tt
Gt
Gt
t − Yt––01
2–––––– + 3rt + 1 –– + 2dt –– + 1 –– + 2dt ––
*
*
*
*
*
*
Yt −1
Yt
Yt
Yt
Yt
Yt *
Yt

+ 3dt + t .

(1)

Y * denotes potential output, (Yt −Yt *)/Yt * the output gap, rt the real interest rate, T/Y *net taxes (taxes net of government transfers) as a fraction of potential output, andG/Y * government purchases, also as a fraction of potential output.4
The variable dt is a dummy designed to capture the conditions that may give rise
to a non-monotonic response of national saving to fiscal impulses. Since we want
to discriminate across various conditions that may trigger such non-monotonic
response, our specifications include a set of such dummies, each corresponding to
one such condition, rather than a single dummy. One dummy variable is set equal to
one during years characterized by a “large and persistent” fiscal impulse (as in GJP),
and zero otherwise. A second dummy is equal to one only if the growth rate of theratio of (cyclically adjusted) gross public debt to trend GDP exceeds 4 percent for
two consecutive years (as in Perotti [1999]). A third dummy is one only if the change
in the spread between the yield on long-term government bonds denominated indomestic currency and the yield on U.S. 10-year Treasuries exceeds the sample mean
by more than 1.5 standard deviations. Note that each dummy dt enters equation(1) both interacted with the two fiscal variables and by itself, to make sure that theinteracted variable only captures the effect of the interaction rather than a possible
independent effect of the dummy on national saving.
In equation (1), the lagged value of the national saving rate is expected to capture
the dynamics of the dependent variable,5 while the output gap should reflect the
response of private saving and of the government surplus to transitory changes inincome. The (ex post ) real interest rate is the difference between the domestic shortterm nominal rate and inflation, based on the private consumption deflator. It is
introduced to control for the direct effect on saving of changes in wealth induced by
3. One advantage of using the national saving as a dependent variable is that it does not depend on the particulardefinition used for private saving. De Mello, Kongsrud, and Price (2004) find that the estimated offset of private
saving depends on the definition used. For instance, they find lower offset coefficients when using household,rather than private, saving. The finding, however, is sensitive to the elimination of outliers, suggesting thatmeasurement errors may be particularly pronounced. Measurement problems are due to the difficulty in accurately
demarcating the household and corporate sectors, given extensive household ownership of businesses via equity
and mutual/pension fund participation. These problems are avoided using national saving as the dependent
variable. Furthermore, national saving is not affected by the redistribution between private and public saving thatis induced by the effect of inflation on the public debt.
4. We scale national saving and fiscal variables by potential output to avoid problems of heteroskedasticity. Dividing
by actual rather than potential output would introduce an endogeneity bias due to the correlation between theerror term and the right-hand-side variables.
5. Equation (1) only allows for very simple dynamics of national saving. De Mello, Kongsrud, and Price (2004) use anerror correction model and allow for more complex dynamics in the adjustment toward the long-term equilibrium.

206 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidencemonetary policy. Since the interest rate is potentially endogenous, we use its lagged
value as an instrument.
Finally, following the specification in GJP, all regressions include a full set ofcountry fixed effects, to account for the possibility that the response of nationalsaving to a fiscal impulse might depend on the particular characteristics of a country,
such as its size and degree of openness to trade. Understanding the effects of fiscal
policy may be easier in a small country, and indeed some of the famous episodes of“non-Keynesian” effects have occurred in small countries, such as Ireland andDenmark. Countries that trade more, either in goods or in assets, may be more
subject to capital market “discipline,” in the sense that it may be easier for saving toexit the country when fiscal policy looks “bad.”
One problem in estimating equation (1) is the potential endogeneity of the fiscal
variables. Such endogeneity may arise from two different sources. Because of theautomatic stabilizers built into the existing tax code, tax revenues and governmenttransfers from and to the economy (which enter our definition of T ) fluctuate withthe business cycle, and are thus affected by the same shocks that affect nationalsaving.6 We deal with this first source of endogeneity by using the full employment
government surplus net of interest payments, as estimated by the OECD, as an
instrument for net taxes.
A second potential source of endogeneity arises from the possibility that thecountry’s fiscal rules themselves respond to the business cycle, which in standard
models is positively correlated with national saving. Our instrumental variables
procedure does not handle this potential bias; GJP further discuss how the bias might
affect the coefficient estimates.7
Our data are an unbalanced panel of OECD countries. The sample used in theestimation and the variables’ definitions are reported in the Appendix. For each
regression, we report results for three sample periods. “Up to 1996” defines the sample
that is closest to our earlier results and thus comparable with the regressions reported
in GJP, although several series have been revised. The other two samples—“up to 2000”
and “up to 2003”—extend our previous results to the more recent period.
A. The Effect of Fiscal Policy during Large and Persistent Fiscal Episodes
We start by estimating a benchmark specification where we do not interact the fiscal
variables with the dummy d, so that the effects of G/Y * and T/Y * are constrained tobe linear. Which signs should we expect on the coefficients of the fiscal variables?
Finite horizon models suggest that an increase in net taxes should raise nationalsaving (1 > 0), whereas an increase in government consumption should reduce it(1 < 0). In the benchmark infinite horizon model with lump-sum taxes, taxes haveno effect on national saving (1 = 0): this is the Ricardian equivalence proposition.
6. Government consumption, on the contrary, is unlikely to fluctuate systematically with the business cycle: fluctuations in unemployment, for instance, affect government transfers, but are unlikely to be correlated with government
purchases of goods and services.
7. There have been a few attempts at constructing measures of exogenous fiscal policy shocks that are not based on
the full-employment surplus. Blanchard and Perotti (1999) identify tax and spending shocks in U.S. quarterly databy assuming that implementing fiscal policy changes requires at least one quarter and by relying on historicalinformation on large discretionary changes in fiscal policy (such as the tax cut in the second quarter of 1975).

207

Also, in the infinite horizon model, for a given path of pretax income, Y, government
consumption does not affect national saving either (1 = 0).8
The results are in Table 2. Column (1) uses the sample that is closer to thatoriginally used in GJP; columns (2) and (3) update the sample to 2000 and 2003,
respectively. The coefficient of T/Y * is positive and statistically different from zero atthe 1 percent level in each regression. When we extend the sample to 2003, the point
estimate becomes smaller, but so does the coefficient of the lagged national saving
rate, so that the long-run effect of taxes—estimated as 1/(1 −  1)—is similar incolumns (1) and (3), 0.51 and 0.53, respectively.
Thus, when we constrain the effect of net taxes to be linear (2 = 0), the results
run against the infinite horizon model and are consistent with the predictions offinite horizon models.
The coefficient of G/Y * is negative and also statistically different from zero at the
1 percent level in both regressions. Contrary to the predictions of infinite horizon
models with non-distortionary taxes, the fall in private consumption does not fullycompensate the increase in government consumption, thereby reducing nationalsaving. In this case too, the point estimate becomes smaller (in absolute value) when
we extend the sample to 2003, but, as in the case of net taxes, the long-run response
is similar.
The results in Table 2, however, are potentially biased because by omitting theinteraction terms they impose that the response of national saving to fiscal variables islinear. Table 3 investigates this issue and contains the main results of the paper. Each
Table 2 National Saving, Taxes, and Government Spending: Baseline Specification

Lagged national saving rate
Output gap
Real interest rate
Net taxes (T /Y * )Government consumption (G /Y * )Observations
Adjusted R-squared

Up to 1996
0.534
(0.036)***0.267(0.039)***0.031(0.029)0.241(0.066)***–0.545(0.059)***
425
0.94

Up to 2000
0.649
(0.033)***0.269(0.039)***0.006(0.031)0.206(0.054)***–0.380(0.056)***
501
0.94

Up to 2003
0.722
(0.029)***0.282(0.035)***0.008(0.030)0.152(0.048)***–0.308(0.052)***
556
0.94

Note: The dependent variable is the ratio of national saving to potential output. Instruments for net
taxes and the real interest rate are the full employment government surplus net of interest
payments (scaled by potential output) and the lagged real interest rate. Countries included in
the estimation and variables’ definitions are reported in the Appendix. All regressions are
estimated with fixed effects. Standard errors are reported in parentheses. One, two, and threeasterisks indicate significance levels at 10, 5, and 1 percent, respectively.

8. Recall that national saving is the difference between national income and total consumption (private plus public):
S = SG + SP = (T − G ) + (Y − T − C ) = Y − (C + G ).

208 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidenceof the three regressions reported in Table 3 tests the hypothesis that fiscal policy
coefficients are stable during periods of protracted and sizable fiscal impulse or during
periods of rapid debt growth. Our hypothesis (supported by our previous findings)
is that non-monotonic responses mostly appear during episodes of protracted andsizable fiscal impulse, as defined above.
Consider first the sample up to 1996. In this sample (column [1]) the effect ofboth T/Y * and G/Y * is highly non-monotonic. During “normal” times, the effect of
net taxes on national saving is positive (1 = 0.684), but during sharp shifts in fiscal
policy the response of private saving virtually cancels any effect of public saving
on national saving: 1 + 2 = 0.684 − 0.665 = 0.019, and we cannot reject the
hypothesis that 1 + 2 = 0 (the p-value of the F-test is 0.88). The same happens forfiscal impulses induced by changes in G/Y *. During “normal” times, an increase ingovernment spending reduces national saving (1 = −1.060) but during sharp shifts
in fiscal policy the response of private saving greatly dampens the fall in nationalsaving: 1 + 2 = −1.060 + 0.777 = −0.283; in this case, the offset is less than
Table 3 National Saving, Taxes, and Government Spending: Distinguishing between“Normal Times,” Episodes of “Large Change in Primary Fiscal Surplus,”
and Episodes of “Rapid Debt Growth”

Lagged national saving rate
Output gap
Real interest rate
Net taxes (T /Y * )—and large change in surplus—and rapid debt growth
Government consumption (G /Y * )—and large change in surplus—and rapid debt growth
Dummy for large change in full
employment surplus
Dummy for rapid debt growth
Observations
Adjusted R-squared

Up to 1996
0.576
(0.052)***0.213(0.061)***
0.042(0.065)0.684(0.229)***–0.665(0.281)**0.434(0.574)–1.060(0.223)***0.777(0.289)***–0.348(0.492)–2.920(1.073)***–1.051(0.512)**425
0.89

Up to 2000
0.660
(0.042)***0.246(0.047)***–0.028(0.052)0.547(0.170)***–0.501(0.228)**–0.177(0.511)–0.777(0.185)***0.613(0.249)**0.177(0.440)–2.694(0.905)***–1.071(0.439)**501
0.91

Up to 2003
0.737
(0.043)***0.268(0.045)***–0.036(0.054)0.527(0.172)***–0.534(0.221)**–0.489(0.608)–0.739(0.179)***0.642(0.241)***0.447(0.524)–2.593(0.906)***–1.092(0.473)**556
0.91

Note: The dependent variable is the ratio of national saving to potential output. Instruments for net
taxes and the real interest rate are the full employment government surplus (scaled by potential
output) and the lagged real interest rate. Countries included in the estimation and variables’
definitions are reported in the Appendix. All regressions are estimated with fixed effects.
Standard errors are reported in parentheses. One, two, and three asterisks indicate significancelevels at 10, 5, and 1 percent, respectively.

209

complete, as the hypothesis 1 + 2 = 0 is rejected at the 5 percent confidence level(the p-value of the F-test is 0.027).
National saving does not appear to respond differently to fiscal impulses carried out
by changing government consumption or net taxes: what matters is the size of theimpulse, not its composition. When we tried to split the “net taxes” variable into “directplus indirect taxes” and “transfers,” the two coefficients were less precisely estimated,but the results suggest that most of the action in the “net tax” variables comes fromshifts in transfers, confirming one of the findings in Alesina and Ardagna (1998)—
namely, that what appears to matter most are changes in Social Security rules.
On the contrary, and confirming the findings in GJP, the coefficient of the dummy
for rapid debt growth, interacted with net taxes or government consumption, is notstatistically different from zero, suggesting that a non-monotonic response of fiscal
policy is more likely to arise when the cyclically adjusted surplus changes significantly,
rather than when public debt grows rapidly.
Columns (2) and (3), where we extend the sample to 2000 and 2003, respectively,
show that the general pattern of these results survives in the more recent data. The
evidence confirms the full offset of the tax coefficient during large fiscal episodes.
In the more recent samples, contrary to the earlier one, we no longer reject the
hypothesis of a full offset of the effect of government consumption during large fiscal
episodes. Finally, the result that rapid debt growth is not a condition giving rise to a nonmonotonic effect of fiscal impulses is confirmed: in none of these regressions are theinteracted coefficients with the dummy for rapid debt statistically different from zero.
B. Are the Effects of Large Contractions Different from Those of
Large Expansions?
The private sector’s response to a fiscal impulse could differ depending on the signof the impulse. To test for the possibility of asymmetric behavior, we interact T/Y *and G/Y * with two separate dummies, one for large fiscal expansions and one forlarge fiscal contractions (the two dummies are then also entered separately). In each
regression, we keep the dummy for rapid debt growth interacted with net taxes
or government consumption. The results in Table 4 report again estimates forthree samples.
In column (1), up to 1996, during episodes of large swings in fiscal policy, private
saving consistently offsets the effects of changes in public saving, independently ofwhether the fiscal impulse is an expansion or a contraction. During contractions
induced by an increase in taxes the offset is complete, as we do not reject the hypothesis that taxes do not affect national saving: the sum between the tax coefficients(0.640 − 0.723 = −0.083) is not statistically different from zero (the p-value of the test
is 0.68). In case of fiscal expansions, the point estimate of the sum of the tax coefficientsis also close to zero and, again, we do not reject the hypothesis that during expansions
the difference between the tax coefficients (0.640 − 0.630 = 0.010) is not statisticallydifferent from zero (the p-value of the test is 0.94). These results confirm the original
GJP findings with the updated series.
During fiscal impulses induced by a change in government spending, we finda complete offset during large contractions: the sum of the two coefficients on

210 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

Table 4 National Saving, Taxes, and Government Spending: Distinguishing between“Normal Times,” Large Fiscal Contractions, and Large Fiscal Expansions

Lagged national saving rate
Output gap
Real interest rate
Net taxes (T /Y * )—and large increase in surplus—and large decrease in surplus—and rapid debt growth
Government consumption (G /Y * )—and large increase in surplus—and large decrease in surplus—and rapid debt growth
Dummy for large fiscal contraction
Dummy for large fiscal expansion
Dummy for rapid debt growth
Observations
Adjusted R-squared

Up to 1996
0.606
(0.066)***0.226(0.067)***0.051(0.068)0.640(0.237)***–0.723(0.339)**–0.630(0.290)**0.620(0.620)–1.071(0.252)***0.853(0.358)**0.731(0.297)**–0.514(0.531)–3.250(1.285)**–2.813(1.546)*–0.899(0.547)425
0.87

Up to 2000
0.700
(0.050)***0.265(0.052)***–0.013(0.055)0.499(0.179)***–0.620(0.294)**–0.472(0.238)**0.204(0.560)–0.792(0.213)***0.785(0.334)**0.524(0.248)**–0.166(0.483)–3.647(1.267)***–1.735(1.213)–0.820(0.476)*501
0.90

Up to 2003
0.765
(0.042)***0.279(0.045)***–0.032(0.050)0.478(0.158)***–0.559(0.226)**–0.523(0.219)**–0.256(0.546)–0.697(0.172)***0.700(0.256)***0.606(0.236)**0.237(0.469)–3.076(1.086)***–2.366(1.156)**–0.935(0.468)**556
0.91

Note: The dependent variable is the ratio of national saving to potential output. Instruments for net
taxes and the real interest rate are the full employment government surplus (scaled by potential
output) and the lagged real interest rate. Countries included in the estimation and variables’
definitions are reported in the Appendix. All regressions are estimated with fixed effects.
Standard errors are reported in parentheses. One, two, and three asterisks indicate significancelevels at 10, 5, and 1 percent, respectively.

government spending (−1.071 + 0.853 = −0.218) is not statistically different from zero.
On the other hand, in the case of expansions induced by large increases in government
spending, the offset is less than complete: the sum of the coefficients (−1.071 + 0.731= −0.340) is statistically different from zero (the p-value of the test is 0.033).
Also when the sample is extended to 2000 and 2003 (columns [2] and [3]), we findthat the response of national saving to large fiscal impulses is non-monotonic andsymmetric for large expansions and large contractions. In the case of fiscal impulses
induced by large changes in net taxes, the offset is complete both in the case of expansions and contractions; in the case of fiscal impulses induced by large changes ingovernment spending, the offset is complete in the case of fiscal contractions and, inthe sample extending to 2003, also in the case of fiscal expansions.

211

Finally, in this specification too the evidence is consistent with the hypothesis that“rapid debt growth” is not associated with a non-monotonic response of nationalsaving to fiscal impulses.
C. Interest Rate Spreads
For spending cuts or tax increases to produce a fall in private saving (and vice versa)
either the market value of nonhuman wealth must rise, or households must anticipate
a higher permanent income. This could happen if fiscal impulses affected households’
expectations. For instance, a spending cut that is sufficiently large and (believed tobe) persistent could signal a future reduction in the tax burden, and therefore an
increase in permanent disposable income (Feldstein [1982]).
Could there be other circumstances under which a fiscal impulse could inducea change in households’ estimate of their permanent disposable income? One possibility (discussed in Blanchard [1990]) is that the response of consumers to fiscal
impulses may differ depending on the perceived sustainability of the fiscal regime.
For instance, when the debt-income ratio is growing rapidly, a fiscal contraction may
provide the signal that a debt default will be avoided: it thus may induce a large
revision in permanent disposable income.
The results in Tables 3 and 4 have shown that a rapidly growing debt-GDP ratio
is not per se a condition for the response of national saving to fiscal impulses to be
non-monotonic. One possibility is that consumers become concerned about rapid
debt growth only when this starts inducing the risk of a default; in other words, only
when interest rate spreads start widening.
In the regressions reported in Table 5, we allow for the possibility that the responseof national saving to fiscal impulses becomes non-monotonic when there is a change
in the spread between the yield on long-term government bonds denominated indomestic currency and the yield on U.S. 10-year Treasuries. Such yields reflect either
expectations of currency depreciation or default premia: when the yield widens, itthus signals that the markets are becoming more concerned about fiscal sustainability.9
In this case, our specification includes an additional dummy that equals one when the
spread exceeds the sample mean by more than 1.5 standard deviations, and zerootherwise. The specifications also include the dummies that were already present in
the regressions of Table 3, and therefore still allow for non-monotonic responses tobe associated with the size and persistence of fiscal impulses and debt growth.
The results in Table 5 tend to confirm that the circumstance most likely to give riseto an offsetting response of private saving remains the size and persistence of the fiscal
impulse. The offset coefficients, however, are much less precisely estimated, possibly
because of collinearity between the dummy for rapid debt growth and the dummy for
9. Caballero and Krishnamurty (2004) suggests a different reason why the effects of a fiscal expansion might dependon the response of bond prices. In countries characterized by relatively thin financial markets, a fiscal expansionthat is large enough to absorb significant amounts of liquidity will be accompanied by a sharp increase in interest
rates and corresponding reductions in households’ financial wealth. Ardagna (2004) finds that stock market prices
surge around times of substantial fiscal tightening and plunge in periods of very loose fiscal policy—and that such
effects are more likely to occur in country years with high levels of government deficits, and when consolidations
are implemented by cutting government spending, and that generate a permanent and substantial decrease ingovernment debt.

212 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

Table 5 National Saving during Large Fiscal Episodes, When Debt Is Growing Fastand When Spreads Widen

Lagged national saving rate
Output gap
Real interest rate
Net taxes (T /Y * )—and large change in surplus—and rapid debt growth—and large change in spread
Government consumption (G /Y * )—and large change in surplus—and rapid debt growth—and large change in spread
Dummy for large change in full
employment surplus
Dummy for rapid debt growth
Dummy for large change in spread
Observations
Adjusted R-squared

Up to 1996
0.562
(0.075)***0.257(0.083)***0.032(0.090)0.648(0.327)**–0.953(0.665)0.482(0.874)1.011(0.978)–1.017(0.344)***1.083(0.702)–0.423(0.763)–1.419(1.213)–3.422(1.828)*–1.794(1.166)
7.564(5.098)425
0.77

Up to 2000
0.641
(0.054)***0.277(0.061)***–0.023(0.068)0.549(0.245)**–0.721(0.516)–0.091(0.739)0.756(0.804)–0.787(0.292)***0.861(0.569)0.080(0.648)–1.129(1.029)–3.269(1.532)**–1.551(0.895)*7.026(4.818)501
0.85

Up to 2003
0.740
(0.058)***0.296(0.055)***–0.025(0.067)0.516(0.215)**–0.707(0.411)*–0.395(0.786)0.645(0.693)–0.715(0.227)***0.845(0.463)*0.347(0.686)–0.998(0.916)–3.205(1.470)**–1.487(0.832)*6.792(4.801)556
0.87

Note: The dependent variable is the ratio of national saving to potential output. Instruments for net
taxes and the real interest rate are the full employment government surplus (scaled by potential
output) and the lagged real interest rate. Countries included in the estimation and variables’
definitions are reported in the Appendix. All regressions are estimated with fixed effects.
Standard errors are reported in parentheses. One, two, and three asterisks indicate significancelevels at 10, 5, and 1 percent, respectively.

the widening of spreads. The dummies set equal to one when debt is growing rapidly
and when spreads widen are not statistically different from zero. Distinguishing
between expansions and contractions (as in Table 4) does not change the results.

V. Conclusions
Data revisions and the availability of a longer sample offer the opportunity to reconsider the empirical findings which suggest that in the OECD countries the responseof national saving to fiscal policy is non-monotonic. Our main results can besummarized as follows.

213

Before considering the possibility of a non-monotonic response—that is, when weconstrain the effect of net taxes to be linear—we find, contrary to the predictions of
infinite horizon models with non-distortionary taxes, that an increase in taxes raises
national saving, and that an increase in government purchases lowers it.
The new data confirm that the circumstance most likely to give rise to a nonmonotonic response of national saving to a fiscal impulse is a “large and persistentimpulse,” defined as one in which the full employment surplus, as a percentage ofpotential output, changes by at least 1.5 percentage points per year over a two-year
period. This particular circumstance remains the only statistically significant one evenwhen we allow for non-monotonic responses to arise when public debt is growing
rapidly or interest rate spreads are widening.
We find that non-monotonic responses are similar for fiscal contractions andexpansions. In particular, an increase in net taxes has no effect on national saving
during large fiscal contractions or expansions. For government consumption, there
is a large, albeit in some specifications less than complete, offset during expansions
or contractions.

214 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence

APPENDIX: DEFINITION OF THE VARIABLES USED IN THE
REGRESSIONS
All variables are drawn from the March 2005 OECD Economic Outlook database.
Public-sector data refer to general government. Definition of the variables and sample
periods are as follows (Appendix Tables 1 and 2).
Appendix Table 1 Definition of the Variables
Definition

Name of the corresponding OECD series(OECD Economic Outlook database)Private consumption

CP

Government consumption

CG

Government savings

SAVG

Government debt

GGFL

Gross national/domestic product

GDPV

Deflator for consumer expenditure

PCP

Taxes net of transfers

SAVG + CG

Government investment

IG

Social security contributions
Social security benefits

SS
SSPG

Full employment government surplus

NLQGA

Potential output

GDPVTR

215

Appendix Table 2 Countries, Sample Period Used in the Estimation,
and Fiscal Episodes
Country

SampleEpisodes of “large and persistent”
used in thefiscal expansion
estimation

Episodes of “large and persistent”
fiscal contraction

Australia

1971–2003 1974–76, 1990–93, 2000–01

1971–72, 1979–80, 1985–88, 1994–97

Austria

1973–2003 1982–83, 1993–95

1973–74, 1984–85, 1996–97, 2000–02

Belgium

1972–2003 1978–80

1972–73, 1981–87, 1992–94

Canada1970–2003 1974–78, 1982–85, 2000–03

1970–71, 1980–81, 1986–88, 1994–98

Denmark

1972–2003 1974–76, 1981–82, 1990–91,
1994–95

1972–73, 1977–78, 1983–87, 1998–99

Finland1977–2003 1979–80, 1982–83, 1986–87,
1990–91, 2001–03

1977–78, 1984–85, 1988–89, 1992–94,
1998–2000

France1972–2003 1977–78, 1981–82, 1992–93,
2002–03

1972–73, 1979–80, 1995–97

Germany

1970–2003 1974–75, 1987–91, 2000–02

1969–70, 1976–77, 1981–83, 1992–94

Ireland1986–2003 1990–91, 2000–02

1980–84, 1986–89, 1993–94

Italy

1964–2003 1971–73, 1978–81, 1984–85,
1998–2001

1964–65, 1976–77, 1982–83, 1990–93,
1995–97Japan

1971–2003 1975–76, 1992–96, 1998–2000

1971–72, 1983–85

Netherlands

1980–2003 1986–90, 1994–95, 2001–02

1980–83, 1991–93, 1996–97

New Zealand 1987–2003 1996–97

1987–91

Norway1979–2003 1989–92, 2001–03

1979–80, 1982–83, 1985–86, 1993–96,
1999–2000

Portugal

1977–2003 1989–90, 1993–94

1977–78, 1981–84, 1991–92, 2001–03

Spain

1980–2003

1980–81, 1986–87, 1991–92, 1995–97

Sweden1980–2003 1990–93, 2001–03

1980–84, 1986–88, 1994–98

UnitedKingdom

1971–2001 1983–84, 1989–93, 2001–04

1971–72, 1974–75, 1979–82, 1995–99

UnitedStates

1966–2003 1970–71, 1974–75, 1982–83,
2001–03

1966–69, 1976–77, 1987–88, 1993–98

216 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Searching for Non-Monotonic Effects of Fiscal Policy: New Evidence
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———, and Roberto Perotti, “Fiscal Expansions and Adjustments in OECD Countries,” Economic
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———, and ———, “Fiscal Adjustments in OECD Countries: Composition and Macroeconomic
Effects,” International Monetary Fund Staff Papers, 44, 1997, pp. 210–248.
Ardagna, Silvia, “Financial Markets’ Behavior around Episodes of Large Changes in the Fiscal Stance,”
mimeo, Harvard University, 2004.
Bertola, Giuseppe, and Allan Drazen, “Trigger Points and Budget Cuts: Explaining the Effects of Fiscal
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———, and Roberto Perotti, “An Empirical Characterization of the Dynamic Effects of Changes in
Government Spending and Taxes on Output,” NBER Working Paper No. 7269, National
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Paper No. 10532, National Bureau of Economic Research, 2004.
de Mello, Luiz, Per Mathis Kongsrud, and Robert Price, “Saving Behaviour and the Effectiveness of
Fiscal Policy,” OECD Economics Department Working Paper No. 397, Organisation for
Economic Co-operation and Development, 2004.
de Rato y Figaredo, Rodrigo, “Benefits of Fiscal Consolidation,” remarks to the Real Academia deDoctores, Barcelona, Spain, on November 25, 2004.
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9 (1), 1982, pp. 1–20.
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Internazionale (Nonlinear Effects of Fiscal Policy: Theory and International Empirical
Evidence),” undergraduate dissertation, Università di Napoli Federico II, 2005 (in Italian).
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217

Comment
REUVEN GLICK
Federal Reserve Bank of San Francisco
The authors’ paper is the latest in a series of papers by Francesco Giavazzi and Marco
Pagano and various co-authors that study episodes of expansionary “fiscal contractions,” that is, episodes characterized by large reductions in fiscal budget deficits thathave been associated with output expansions. The view that fiscal contractions can be
expansionary has been characterized as the “German view” in light of statements by
the German Council of Economic Experts in the early 1980s that fiscal contraction
could set the foundation for an economic expansion in Europe. In the United States,
this view sometimes has been labeled “Rubinomics” after Robert Rubin, who was
U.S. Treasury Department Secretary in the mid-1990s when the United States reduced
its fiscal deficits and simultaneously experienced lower interest rates and higher
investment and growth.
The focus of the paper is on measuring the effects of fiscal policy on nationalsaving. More specifically, it asks if and by how much does private saving decline in
response to contractionary fiscal policy. The implied premise is that the more private
saving declines, the more likely it is that fiscal consolidation has an expansionary
effect on consumption and output.

I. Quick Review of Background Theory and Empirical Work
Let me begin my comments by providing a quick review of the relevant theory andempirical work. Some of this material is presented in other work by the authors but
mostly omitted from the current paper. It is useful to have this material in mind tounderstand the logic of the results as well as to fit the paper into the larger literatureof fiscal policy effectiveness.
In a basic Keynesian framework, a tighter fiscal policy contracts the economy
as higher taxes and lower government spending both reduce aggregate demand.
To the extent that the interest rate falls because of decreased government borrowing,
this effect is offset somewhat by the crowding in of investment and other interestsensitive demand. On balance, however, the effect of contractionary fiscal policy
reduces output as long as money demand is interest elastic. But there are otherso-called “non-Keynesian” channels through which fiscal policy can affect consumption, investment, and aggregate supply. For example, if fiscal consolidation lessens
the future expected tax burden, permanent income and current consumption may
rise. Lower interest rates can increase discounted income streams and wealth, which
also boosts consumption. If fiscal consolidation leads to lower wages in the private
sector and a lower tax burden on firms, expected profits may rise, fostering moreinvestment, aggregate supply, and growth.
The authors argue that these non-Keynesian effects may be non-monotonic, thatis, large fiscal changes have a proportionately greater impact on aggregate demand

218 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

than do small changes. One crude explanation is the existence of threshold effects
to learning, implying that fiscal impulses must exceed some threshold to prompt
revisions in expectations about future tax burdens and spending. Another story works
off of tax distortions (Blanchard [1990]). If future taxes are inefficiently high, raising
current taxes and lowering future taxes may greatly reduce the deadweight costs offuture taxes. Still another story involves the path of government debt. If public debt ishigh and the fiscal deficit is perceived to be on an unsustainable path, then a large fiscal
contraction may lead to a significant reduction of expected future spending and taxes.
The authors’ paper is also part of a larger literature on the effectiveness of discretionary fiscal policy. One strand involves using vector autoregressions to estimate
output multipliers of discretionary fiscal policy. For example, Blanchard and Perotti(2002) find that fiscal policy multipliers for the United States are positive thoughsmall, in other words, expansionary fiscal policy increases growth. Another strand
uses real business cycle and structural models to simulate the effects of discretionary
monetary policy (e.g., Ramey and Shapiro [1998]). A third strand involves individual
case studies, including early work by Giavazzi and Pagano (1990) on budget adjustment in Denmark and Ireland, as well as cross-section and panel studies. The latterincludes work by Alesina et al. (2004) that estimates investment effects and workby Giavazzi and Pagano (1996) and Giavazzi, Jappelli, and Pagano (2000) that has
estimated consumption equations, or equivalently saving equations.

II. Overview of the Paper
The starting place of the authors’ paper is a rearrangement of the national income
accounting relation into the condition that national saving equals the sum of private
saving and fiscal surplus, which in turn is equal to domestic investment plus foreign
investment through the current account surplus. The authors then ask what is theeffect of tax increases or government spending cuts on national saving, in otherwords, by how much does private saving offset changes in the budget surplus?
This gives a direct test of Ricardian equivalence. Indeed, there is good evidence thatprivate saving moves inversely to fiscal surpluses, dampening the change in nationalsaving (Organisation for Economic Co-operation and Development [2004]). The
authors emphasize that for large changes in fiscal policy the offsetting changes inprivate saving are even larger, implying a nonlinear relationship.
The empirical analysis involves estimation of a reduced-form saving equation byregressing the saving rate on taxes and spending, lagged saving to deal with dynamics
and some control variables, including the output gap and the real interest rate. The
effects of fiscal nonlinearities are tested by interacting dummies with taxes andspending. These dummies are defined in three ways: (1) large changes in the sizeof the surplus, that is, changes in the full employment budget surplus greater than
1.5 percentage points per year for a two-year period; (2) annual growth in the public
debt-GDP ratio that exceeds 4 percent per year for two years; and (3) and deviations
between the long-term interest rate for long-term government bonds and 10-year U.S.
Treasuries that exceed the mean level by 1.5 standard deviation units. This empirical219

analysis is essentially an update of earlier work by Giavazzi, Jappelli, and Pagano (2000)
that extends the dataset for OECD countries from 1964–96 to 1964–2003.
Figure 1 shows their estimated short-run responses of national saving to “normal”
and “large” tax rises and government spending cuts, based on the results in Table 3of their paper, which also include dummies for rapid public debt growth (the longrun responses can be obtained by dividing by one minus the coefficient on laggedsaving). The main points of the paper can be drawn from this figure:• First, the magnitude of fiscal policy contraction matters. For “normal” taxincreases and government spending cuts, national saving rises, implying fiscal
policy is contractionary. For “large” fiscal contractions, saving rises less andmay even fall, since offsetting private saving effects are larger. Thus, for large
contractions, fiscal policy is less contractionary.
• Second, the composition of fiscal contraction matters. Tax increases raise savingby less than government spending cuts, since the offsetting fall in private saving
is larger.
• Third, the sample period matters. The response is smaller when the sample
is extended from 1964–96 to 1964–2003. I will come back to this particular
result below.
Figure 1 Estimated Coefficient Responses of National Saving to “Normal” and“Large” Tax (T ) Rises and Government Spending (G) Cuts
[1] 1964–96
1.0

0.5

0.0

–0.5
Normal T rise

Normal G cut

Large T rise

Large G cut

Normal G cut

Large T rise

Large G cut[2] 1964–2003
1.0

0.5

0.0

–0.5
Normal T rise

Source: Giavazzi et al. (2005, table 3).

220 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

III. Comments and Suggestions
I have several comments, questions, and suggestions for the authors. My intention in raising these points is not just to provide constructive suggestions to the authors for future
work, but also to motivate other researchers in the field who seek to build upon their paper.
A. Measurement of Fiscal Policy Stance
Current taxes and government spending do not fully capture the stance of fiscal
policy. First, fiscal policies may be backloaded, if, for example, tax increases arescheduled for later in a consolidation program. Second, fiscal reforms, for instance,
pension reforms, may have a limited effect on the current budget balance position,
but may have a large effect on the long-term government budget and on permanent
income. Lastly, fiscal policy may stimulate current demand without any change in thecurrent budget deficit by affecting aggregate demand through a change in relative
prices, such as an investment tax credit. For these reasons, the measure of fiscal policy
used in the paper may not totally reflect the effects of fiscal policy in some cases.
B. Are the Coefficient Estimates Consistent?
The estimated saving equation has a lagged saving rate as a right-hand-side variable.
In a panel sample, coefficient estimates may be inconsistent in the presence of alagged dependent variable and serially correlated errors. In an earlier version of thepaper, the authors argue that this bias is likely to be small when the time dimensionof the panel sufficiently exceeds the cross-section dimension. But this presumes thatthe estimated coefficients are homogenous across countries, for example, the coefficienton lagged saving is the same in the United States as in other OECD countries. HereI would suggest testing this homogeneity restriction formally. If the restriction isrejected, a dynamic panel estimator that gives consistent estimates, such as thatdeveloped by Arellano and Bond (1991), is in order.
C. Controlling for Endogeneity
Taxes and government spending are potentially endogenous for two reasons: (1) automatic stabilizers (taxes and spending depend directly on output and income levels);and (2) policy rules (discretionary changes in taxes and spending may depend on the
output gap through a feedback policy followed by policymakers). In their paper, theauthors address the first problem by instrumenting the tax variable with the full
employment primary budget surplus, but they do not adjust government spending.
With respect to the second source of possible endogeneity, it might be argued thatthe bias due to a possible policy rule is small if the correlation of budget surplus
changes and the output gap is zero for large fiscal changes. But the International
Monetary Fund (2004) finds that discretionary budget surpluses in the European
Union have been procyclical since the mid-1990s: the cyclically adjusted surplus rosewith output in the late 1990s to meet Maastricht goals, while it fell with the output
downturn in 2001–03. So the authors need to consider whether it is true that thebias due to endogeneity of taxes and spending through the output gap is small,particularly in the latter part of the sample.

221

D. Role of Other Factors Affecting Saving and Growth?
The authors make some effort to assess the role of other financial developments, suchas public debt growth and interest differentials. But none of these factors when interacted with the fiscal variables is found to be significant. Moreover, there are lots ofother factors that may also have affected consumption and output at the time of
fiscal policy changes. Factors such as productivity growth, monetary policy, andexchange rate changes, among others, may all affect the link between fiscal consolidations and economic activity. For example, why did output grow after the Clinton
administration fiscal consolidation of 1993–94? Certainly the productivity boom
starting in the mid-1990s played a role in this output expansion. Why have the tax cuts
and increased fiscal deficits of the George W. Bush administration apparently been
expansionary, rather than contractionary, if non-Keynesian effects had been working
strongly? Was it because of low interest rates engineered by Federal Reserve monetary
policy? Lastly, what is the role of exchange rate policy? According to Lambertini
and Tavares (2003), significant currency depreciation preceded some expansionary
fiscal contraction episodes. For example, the currencies of Ireland and Denmark
each depreciated before fiscal changes that created competitiveness advantages that
contributed to the subsequent economic growth. Thus, the estimation needs tocontrol for the roles of other factors, such as the effects of productivity, monetary
policy, and exchange rate changes, to properly identify the effect of fiscal policy.
E. Why Have the Effects of Fiscal Policy Declined since 1996?
As noted above, the (short-run) coefficients of both normal and extreme fiscal policychanges decline with the addition of the 1997–2003 period observations. It would be
useful to carry out a formal test of whether there has been a regime shift in fiscal
policy multipliers between 1996 and 2003 using, for example, a Chow test or othertest of parameter stability. In any event, the authors should ponder this result andprovide some explanation for it. One possible reason is that membership in theEuropean Monetary Union (EMU) has ended the ability of member countries in thesample to control their national exchange rates and national monetary policy. To theextent that the ability to devalue the exchange rate against major trading partners
and engineer independent monetary policies was an important element in fostering
successful fiscal adjustment, the locking in of exchange rates after 1993 within the
EMU and the adoption of the euro may have reduced the effectiveness of fiscal policyin the latter part of the sample.
F. Do the Non-Keynesian Channels Work in the United States and Japan?
A final question has to do with the relative importance of the non-Keynesian channels
in the cases of the United States and Japan, the two largest countries in the sample.
Other work and casual observation suggest that these channels may not be very
important for these countries. Specifically, Kuttner and Posen (2001) conclude in thecase of Japan that, after properly controlling for the endogenous effect of income on
tax receipts, fiscal policy has worked in a Keynesian way in the past decade. Whentaxes were increased in 1997 by over 2 percent of GDP, output fell (this episode does
not appear in the authors’ sample of large changes because it lasted only one year).

222 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

When government spending was increased in 1997–98, output rose. Similarly, in thecase of U.S. fiscal policy, when taxes were cut and government spending raised in
2001–03 and the budget deficit rose, output rose as well. To see if Japan and the UnitedStates have behaved differently, it would be useful to formally test if the effects of fiscal
policy in these two countries do indeed differ from those of the other countries inthe sample.
Presuming that there is a difference, what is the explanation for the apparent
absence of non-Keynesian effects for the United States and Japan? Evidently concern
about future budget deficits does not appear to have a significant depressing effect on
current spending in either of these countries, inasmuch as long-term interest rates
have remained relatively low in both cases. Possibly the answer has to do with the credibility of policymaking institutions in the United States and Japan. This credibility haslessened the concern that the central bank will inflate away the value of the debt and/or
the fiscal authorities will default on their liabilities. Consequently, non-Keynesianeffects related to concerns about future tax liabilities have been muted.

References

Alesina, Alberto, Silvia Ardagna, Roberto Perotti, and Fabio Schiantarelli, “Fiscal Policy, Profits, andInvestment,” American Economic Review, 92 (3), 2004, pp. 571–589.
Arellano, Maurice, and Stephen Bond, “Some Tests of Specification for Panel Data: Monte Carlo
Evidence and an Application to Employment Equations,” Review of Economic Studies, 58, 1991,
pp. 277–297.
Blanchard, Olivier, “Comment on Giavazzi and Pagano,” NBER Macroeconomic Annual 1990,
Cambridge, Massachusetts: MIT Press, 1990, pp. 111–116.
———, and Roberto Perotti, “An Empirical Characterization of the Dynamic Effects of Changes in
Government Spending and Taxes on Output,” Quarterly Journal of Economics, 117 (4), 2002,
pp. 1329–1368.
Giavazzi, Francesco, Tullio Jappelli, and Marco Pagano, “Searching for Non-Linear Effects of Fiscal
Policy: Evidence from Industrial and Developing Countries,” European Economic Review,
44 (7), 2000, pp. 1259–1289.
———, ———, ———, and Marina Benedetti, “Searching for Non-Monotonic Effects of Fiscal
Policy: New Evidence,” Monetary and Economic Studies, 23 (S-1), Institute for Monetary andEconomic Studies, Bank of Japan, 2005, pp. 197–217 (this issue).
———, and Marco Pagano, “Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small
European Countries,” NBER Macroeconomic Annual 1990, Cambridge, Massachusetts: MIT
Press, 1990, pp. 75–111.
———, and ———, “Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and theSwedish Experience,” Swedish Economic Policy Review, 3 (1), 1996, pp. 67–103.
International Monetary Fund, World Economic Outlook, 2004, Chapter 2.
Kuttner, Kenneth, and Adam S. Posen, “The Great Recession: Lessons for Macroeconomic Policy fromJapan,” Brookings Papers on Economic Activity, 2, 2001.
Lambertini, Luisa, and Jose Tavares, “Exchange Rates and Fiscal Adjustments: Evidence from the OECDand Implications for EMU,” Boston College Working Paper No. 576, Boston College, 2003.
Organisation for Economic Co-operation and Development, “Saving Behavior and the Effectiveness of
Fiscal Policy,” Economic Outlook, 76, December, 2004, Chapter 5.
Ramey, Valerie, and Matthew Shapiro, “Costly Capital Reallocation and the Effects of Government
Spending,” Carnegie-Rochester Conference Series on Public Policy, 48, June, 1998, pp. 145–194.

223

Comment
ROBERT H. RASCHE10
Federal Reserve Bank of St. LouisThe analysis in the session paper is a sequel to a number of other studies by a subgroup of the current authors. In particular, see Giavazzi, Jappelli, and Pagano (2000).
I have some concerns about the structure of these analyses that I will discuss below.
The authors’ analyses use panel datasets. The session paper’s Appendix lists
19 countries with annual data spanning up to 40 years in one country. There is a
substantial number of missing data points, resulting in unbalanced panels. Data for
Italy and the United States start in the mid-1960s. The shortest samples are for New
Zealand and Ireland, where the data start in 1987 and 1986, respectively. With the
exception of the United Kingdom, the data extend through 2003.
The fundamental hypothesis in this analysis is that the saving ratio responds
differently to large and persistent fiscal expansions or contractions than to morenormal fiscal impulses. “Large and persistent” is defined in terms of fiscal expansions
or contractions that exceed 1.5 percentage points in terms of the full employment
surplus, and that persist for two years. In this analysis, the 1.5 percentage point
threshold is taken as given, though in Giavazzi, Jappelli, and Pagano (2000) sensitivity analysis is undertaken for that particular threshold. In the sample used there,
which is shorter than the sample in this analysis, the conclusions appear to be robust
to the choice of the threshold.
An interesting characteristic of the data in this sample, as well as in the sample ofthe previous analysis, is that a relatively large fraction of observations received the“treatment”; that is, they correspond to a large and persistent fiscal expansion orcontraction. The observations that receive the treatment appear to be scattered fairly
uniformly across the countries and across the sample (see the session paper’s Appendix).
I confess that I am uncomfortable with the approach of gathering as much data as
possible, and throwing it into the personal computer or statistical package to grind it up
and see what comes out. I believe that there are better ways to approach the analysis,
which I will come to a little later. I can cite two points as a rationale for my discomfort.
First is the issue of outliers and how the results are affected by outliers. Second is theissue of specification and measurement errors that I believe are substantial here.
Consider Figure 1, which is reproduced from Giavazzi, Jappelli, and Pagano(2000). This figure has the data from a sample of OECD countries that ends in
1996.11 The dependent variable on the vertical axis of this figure is the change in thenational saving rate. The independent variable on the horizontal axis is the change
in the full employment surplus. To be fair to the authors, this is not the regression
they report in their various tables. However, three things are noteworthy. I can pickout six data points (circled in bold in Figure 1). These six points are outliers and, in
10. The opinions expressed here are mine and do not reflect the official position of the Federal Reserve System.
11. The data through 1996 employed in this analysis are revised from those previously available. Greece has been
dropped, and New Zealand and Norway have been added to the dataset since the previous analysis. The range ofthe data has been changed for many of the remaining countries.

224 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

Figure 1 Year-to-Year Change in Full Employment Surplus
Change in national saving rate

5

0

–5
–5.0

–1.5

0.0

1.5

5.0
Change in full employment surplus

particular, one is way up at the top of the graph and two are way out to the right andbelow. These points have the tendency to pull the right end of the rightmost line
segment down and, absent knots in the piecewise regression, would tend to pull theleft end of the same segment up. Another outlier is in the upper left of the graph.
This point will pull up the left end of the leftmost line segment. What happens if
those outliers are ignored? I have drawn a large (gray) ellipse around the data points
remaining after eliminating the outliers. The scatter within the ellipse looks pretty
random. It is not clear that there is anything systematic about those points, either
below the –1.5 percent threshold, between –1.5 percent and 1.5 percent, or above
the 1.5 percent threshold.
My conclusion from this analysis is that the panel may include a few large outliers
that substantially affect any estimated coefficients, particularly when regression lines
are fitted in a piecewise fashion. Care should be taken to analyze such outliers, and all
regression results should be tested to determine if they are robust to the inclusion of
those observations.
The estimating equation that the authors use is*St −1 +  Y
Tt
Tt
Gt
Gt
S–t =  +  –––t − Yt––01
2–––––– + 3rt + 1 –– + 2dt –– + 1 –– + 2dt –– + 3dt ,
*
*
*
*
*
Yt −1
Yt
Yt
Yt
Yt
Yt *
Yt

where St is national saving, Y * is potential output, (Yt −Yt *)/Yt * is the output gap, rt an
ex post real interest rate, Tt /Yt * the ratio of taxes to potential output, and Gt /Yt * theratio of government consumption to potential output. dt represents a vector of dummy225variables that allow the slope and intercept of the regression line to change when theobservation corresponds either to a large and persistent fiscal expansion or contraction,or to a high growth rate of the (cyclically adjusted) gross public debt, or a large spread
between the long-term government bond yield and the 10-year U.S. Treasury yield.12
The authors do not specify the model from which this equation is derived.
At first glance, the equation could be viewed as a reduced form, though technically
it is not. The authors indicate that they have performed an instrumental variable regression with instruments for the interest rate and the tax ratio (see notes to the authors’
Tables 2–5). In a true reduced-form equation, the variables on the right-hand side areexogenous—causality runs strictly from these variables to the dependent variable, andthere is no need to instrument the regressors. Presumably within the model that theauthors have in mind is a rule or a law that determines how the taxes are endogenously
generated. Real interest rates presumably are also jointly determined with the saving
ratio in that model.
It is not exactly clear how the output gap is treated in the instrumental variable
regression. In the notes to the authors’ Tables 2–5, there is no mention of the output
gap being instrumented. However, in models that I am aware of, which include
an output gap and a saving ratio, the two variables are jointly determined, so the
problem of simultaneous equation bias exists here too. This leaves the government
consumption ratio as the only exogenous variable in the specification. Variables suchas oil shocks, changes in terms of trade, productivity shocks, and a long list of othervariables that could reasonably be expected to be exogenous for at least some of thecountries in the sample are conspicuously absent from the regression. It is likely that
there are omitted variables which generate specification error.
The full employment primary surplus is indicated as the instrument for net
taxes. That seems like a peculiar instrument. Neither government consumption nor
government investment is instrumented. Would not the full employment primary
surplus plus government consumption, or perhaps government consumption plus
government investment, be a better instrument for net taxes? Certainly that measurecan be easily constructed from the data used in the regressions.
The results of the empirical analysis are perhaps best understood by working fromthe most general specification in the authors’ Table 5 to the most specific in Table 2.
In Table 5, the estimated slope coefficients on the interaction of dummy variables
for rapid debt growth and large changes in interest rate spreads with net taxes
and government expenditures are not significantly different from zero. Nor are
the estimated coefficients on these dummy variables by themselves significant. It
would have been helpful if the authors had provided the result of an F-test that these18 estimated parameters are simultaneously equal to zero. That information would
support (or reject) the restricted specifications in the authors’ Tables 3 and 4.
In the authors’ Table 4, the authors report the result of omitting the dummy
variable for large changes in interest rate spreads, both in interaction and stand-alone
form. With these restrictions, the estimated coefficients on the interaction of the rapid
debt growth dummy variable with the net taxes and government consumption variables
12. Presumably this dummy variable is always zero for the United States.

226 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

remain insignificant, though the estimated coefficient on the dummy variable itself is
estimated with more precision and becomes significant as the sample size is extended
from a terminal date of 1996 to a terminal date of 2003. The specification in this tableretains the distinction between large increases and decreases in the cyclically adjusted
surplus. The estimated coefficients on the interactions of large surpluses and large
deficits with both net taxes and government consumption are similar in size. The point
estimates of the coefficients of the fiscal expansion and contraction dummies aresubstantially different, but they are estimated with large standard errors. It would havebeen interesting had the authors provided an F-test of the equality of the estimatedcoefficients involving the two dummy variables in support of the restrictions that are
implicit in going from the specification in the authors’ Table 4 to that in Table 3. Since
the adjusted R-squares in Table 3 are larger than those of the corresponding regressions
in Table 4, the reader can probably safely infer that those restrictions are not rejected.
The authors’ preferred set of results is that appearing in Table 3. This specification
allows for interactions between both the large change in the surplus dummy and therapid debt growth dummy and the fiscal variables. It also includes the two dummy
variables by themselves. The authors note that the estimated coefficients of the interactions with the rapid debt growth dummy are not significantly different from zero.
They also cite the significant estimated coefficients on the interactions of the change
in surplus dummy with the fiscal variables as support for their hypothesis of a nonmonotonic effect of fiscal policy. They also note that for the longest sample period
the changes in size of net taxes and government consumption relative to potential
GDP have no effect on national saving in the regime of large changes in the surplus(the estimated coefficients on the fiscal variables are not significantly different fromthe estimated coefficients on the corresponding interaction terms). The reader should
be careful to note that this result only implies that there is no marginal effect of the
fiscal variables in the large surplus environment. The estimated coefficient on the
dummy variable is significantly different from zero, indicating that on averagenational saving is lower in periods when there is a large change in the surplus.
The results reported in the authors’ Table 2 are additional restrictions on thespecification from those reported in Table 3. Relative to Table 3, the specification in
Table 2 constrains the coefficients on all the terms involving the dummy variables tozero. In Table 3, the estimated coefficients on both dummy variables are reported
to be significantly different from zero, as are those on the interaction terms with thefiscal variables. Yet a comparison of the adjusted R-squares reported in Table 2 withthose in Table 3 indicates substantially higher values in Table 2. These results are
difficult to reconcile, and a more detailed analysis of the restrictions is warranted.
What really is of interest is how private saving responds to fiscal actions. The
dependent variable in the regression equation is the total saving ratio. But totalsaving is just government plus private, which is net taxes minus government
purchases plus private saving. So the government saving can be subtracted fromboth sides of the regression, with the resulting coefficients of  − 1 on net taxes, and + 1 on government consumption.13 These are the coefficients on the T ratio and
13. There would also be an additional term, government investment, on the right-hand side of the regression with acoefficient of 1.0.

227

the G ratio themselves, not the coefficients of the interaction terms. In the shorter
samples,  + 1 is not significantly different from zero. In the longest sample,  + 1
approaches significance.
How can we understand what is going on here? I think a more interesting andinformative way to look at this question would be to use a technique that rarely
appears in econometrics texts, but is well known in other disciplines. This is replication. There are over 30 years of data from 11 countries. The observations that receive
the large fiscal shock treatment are fairly uniformly spread across the countries andacross time. It would be informative to separate the data into four roughly equal
eight- to nine-year subsamples and replicate the analysis across the subsamples.
Alternatively or additionally, replication could be used in the cross-section dimensionof the dataset. Subpanels of three to four randomly selected countries could becreated. Then the stability of the estimated coefficients across the replicates could be
examined. Are the results robust in different subsamples/subpanels? Do they change
in a systematic fashion? I believe that the replication technique would give better
insight into the robustness or fragility of the evidence for the hypothesis than can begleaned by putting all the data into one big regression as is done here.
Because of autocorrelation, such subsamples might not be truly independent as
would be the case when two groups of people are selected and one group is given adrug and one group a placebo. But autocorrelation is likely quite low among subsamples, and the replication will give a better idea of robustness of these results than
the standard errors from the basic regression program.
Finally, there is one other measurement issue. The saving defined here is the
National Income and Product Account (NIPA) definition of saving. It is a wellunderstood concept and standardized across countries. But it is not the only conceptof saving available. In particular, Figure 2 gives three different measures of thepersonal saving ratio for the United States. This is the ratio of personal saving relative
to GDP, it is not a national saving ratio. These measures come from the Federal
Reserve’s flow of funds statistics. One line is the ratio of NIPA personal saving toGDP. The other two lines are flow of funds personal saving ratios, one of which
includes consumer durables and one of which excludes them. As far as the trends areconcerned, they look very similar, although it is interesting that all of the lines havea small positive trend until the late 1980s or early 1990s and since then they show
a significant negative trend. This break in trend may be unique to the UnitedStates, but it is not caught in the authors’ regression equation. I am not sure thatanybody has a good explanation for this break, but how it affects the results should
be a concern.
Consider the changes in these three personal saving ratios, shown in Figure 3.
These changes are quite volatile, and there are many instances where the flow of funds
measures give large changes and the NIPA measure does not. The flow of funds
measures include capital gains, the national income one does not. In cross-country
analyses, the treatment of consumer durables could be important. A personal example:
I managed to live in Tokyo for three months without ever driving a car. I cannot livein St. Louis for three hours without driving a car, which illustrates that transportation
services are consumed in strikingly different ways across countries. This should be

228 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005

Comment

Figure 2 Three Measures of Personal Saving to GDP: United States

14

Percent

12
10
8
6
4
2
0
–2
1946 49 52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 2000 03
Flow of funds personal saving ratio with consumer durables
Flow of funds personal saving ratio excluding consumer durables
NIPA personal saving ratio

Figure 3 Three Measures of Changes in Personal Saving Ratio: United States

4

Percent

3
2
1
0
–1
–2
–3
–4
–5
1947 50 53 56 59 62 65 68 71 74 77 80 83 86 89 92 95 98 2001 04
Flow of funds personal saving ratio with consumer durables
Flow of funds personal saving ratio excluding consumer durables
NIPA personal saving ratio

taken into consideration when thinking about how saving should be measured. Just toemphasize the point, correlations of the three measures of change in personal saving
rates for the United States can be computed. The changes in the two flow of funds
saving ratios are very highly correlated, 0.92. The correlation of the flow of fundswith consumer durables measure against the NIPA measure is only 0.37. Even when
consumer durables are excluded from both concepts of saving, the correlation is only229

0.52. Again, measurement issues appear to be important. It is appropriate to consider
what concept of saving is relevant to investigate the questions at hand.

Reference

Giavazzi, Francesco, Tullio Jappelli, and Marco Pagano, “Searching for Non-Linear Effects of Fiscal
Policy: Evidence from Industrial and Developing Countries,” European Economic Review, 44 (7),2000, pp. 1259–1289.

General Discussion
Responding to comments made by the discussants, Francesco Giavazzi noted that the
reduced-form estimation implicitly assumed a standard consumer behavior modeland tried to control other conditions that could possibly produce a non-Keynesianeffect. He agreed that the endogeneity problem might become more serious in thesecond part of the sample period, reflecting the tendency of governments, especiallyin the countries of the European Union (EU), to follow a fiscal policy rule moreconsistently than before.
Giavazzi agreed that exchange rate channel played an important role in stimulating economic activity, as observed in Denmark and Ireland in the 1980s and Italy inthe mid-1990s. However, he added that such a mechanism was not expected to workwithin the euro area at present. He agreed that the inflow of foreign capital into theUnited States had contributed to the low interest rate, thereby enhancing theKeynesian effect in the United States. However, he added that Japan’s experience
seemed less favorable to the Keynesian effect as a large fiscal expansion throughgovernment investment did not seem to produce the traditional expansionary effect.
Following Giavazzi’s response to two discussants, some participants emphasized
the role of the private sector’s expectations. Ulrich Kohli (Swiss National Bank) notedthat changes in government expenditure should be divided into temporary andpermanent components. He added that the negative coefficient on government
expenditure did not necessarily contradict the Ricardian equivalence hypothesis,
because if the increases in government expenditure were expected to be temporary,then nothing much would happen to private consumption and therefore nationalsavings would fall. Janet L. Yellen (Federal Reserve Bank of San Francisco) noted thepossibility that current changes and future expected changes in fiscal policy had
opposite impacts on output. More precisely, tighter current fiscal policy should becontractionary, whereas expectations of tighter fiscal policy in the future could be
expansionary because it would lower future expected short-term interest rates andthus current long-term interest rates. Yellen mentioned that “Rubinomics” could
be most coherently explained by the scenario that a path of backloaded progressive
fiscal tightening produces a current expansionary effect. José Luis Malo de Molina(Banco de España) suggested that the possible dominance of the Ricardian effect was
mainly related to the private sector’s perception of the constraints on public-sector
solvency in the long run. He noted that the empirical model should capture the

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General Discussion

initial position of the public sector in terms of the size of the deficit or surplus andthe amount of debt, rather than the size or persistency of fiscal impulses.
Concerning the comment on temporary versus permanent changes in fiscal policy
and backloaded adjustment, Giavazzi agreed with the importance of these points. He
emphasized that because we do not know, when a policy is announced, whether itwill be permanent, what mattered most was what the currently available informationon the fiscal package told us about the future course of fiscal policy. He added thatsuch information contents might be different for a large policy package than for asmall one. To the comment on the size of debt, he responded that, although Olivier
Blanchard’s model clearly explained how changes in households’ expectations caused
contrasting effects when the amount of debt went beyond a certain threshold, he
could not find empirical results supporting such a mechanism.
Shigenori Shiratsuka (Bank of Japan) suggested another interpretation of a nonKeynesian effect of fiscal policy based on a waiting-option motive for saving. Whenthe fiscal situation was getting worse and uncertainty in the economy was growing,households tended to avoid making irreversible commitments and to postpone theirexpenditure decisions until a time when the uncertainties would be resolved. Giavazzi
agreed that confidence and the option value of waiting were important.
Hiroshi Fujiki (Bank of Japan) proposed a variable for controlling the effects of astricter implementation of fiscal rules in the 1990s than in the late 1980s: an index
for a budgetary institution, as proposed by von Hagen (1992), to take care of thequality of fiscal rules.14
As for the Keynesian effect in the United States and Japan, Shiratsuka introduced apaper by Itoh and Watanabe (2004),15 which found non-Keynesian effects in Japan by
employing cross-prefecture panel data. In addition, Shiratsuka mentioned that there
were many studies about the decline of the fiscal multiplier in the 1990s in Japan.
Jean-Philippe Cotis (Organisation for Economic Co-operation and Development)
provided a counterexample as recent research by the OECD using an error correction
model, which enabled the clear separation of long-run and short-run dynamics, foundno private savings offsets to changes in public deficits for the United States.
To conclude, Giavazzi emphasized that we should be careful in extracting policy
implications from the empirical evidence shown in his paper, as well as in otherrelated studies. He was concerned that policymakers tended to generalize aboutsuch evidence and to conclude that fiscal consolidations were always beneficial tothe economy.

14. See Jürgen von Hagen, “Budgeting Procedures and Fiscal Performance in the European Communities,”
European Economy Economic Paper No. 96, Commission of the European Communities, 1992.
15. See Arata Itoh and Tsutomu Watanabe, “Zeiseiseisaku no Hi-Keinjian Koka (Non-Keynesian Effect of Fiscal
Policy),” Keizai Kenkyu (Economic Review), 55 (4), Hitotsubashi University, 2004, pp. 313–327 (in Japanese).

231232 MONETARY AND ECONOMIC STUDIES (SPECIAL EDITION)/OCTOBER 2005