Effects of Fiscal Consolidation in the OECD aggregate demand) for the contracting economy as well as being negative for the foreign economy for unchanged prices. Where the ambigwities arise are through the changes in goods and asset prices. Te important link is between the change in the fiscal deficit and the change in interest rates, the change in interest rates and the change in real activity, and the change in interest rates which affects exchange rates and through that channel, net exports.

In terms of the transmission of the fiscal contraction to other countries, the key channels are through the extent of trade between the two economies as well as the degree of capital mobility (as well as the assumption about input price changes as is familiar from early results in the Mundell-Fleming Model under alternative wage assumptions (see Bruno and Sachs (1979)). For example, as U.S. demand contracts, this reduces imports from other economies which is a negative demand shock for those economies. This is then offset through lower real interest rates if private capital flows into those economies.

There is a large literature on the links between changes in fiscal deficits and change in interest ates. In theory, the link between deficits and interest rates depends on whether the deficit change is due to a change in taxes or a change in spending on goods and services. In a Ricardian world (see Barro (1972)) there is no link between interest rates and deficits caused by a change in taxes. The deficit is internalized by consumers, and thus total saving and total investnent does not change as taxes change. When government spending changes, even in a Ricardian model there can be changes in interest rates during the transition to a new steady state (see Zhang(1993 **)** . A number of tests of the Ricardian equivalence proposition tend to reject it (see for example Bernheim ( 1987 )) although even this is not consensus (see Seater(1993)). The failure of the extreme form of Ricardian equivalence indirectly provides empirical support for the link between deficits and interest rates.

More direct tests tend to be less clear. Evans (1985,1987) and Barro (1989) found little evidence of the link between fiscal deficits and interest rates. A comprehensive survey of the evidence can be found in Barth et al (1989). These latter authors amongst others note the many problems that arise in undertaking the empirical testing including the problem of calculaing real interest rates and the appropriate concept of fiscal deficit to use in regressions. In a recent study, using data on 13 OECD countries Tanzi and Lutz (1991) found strong positive correlation between govermnent debt and long termn interest rates. The evidence for fiscal deficits was less clear but the results for the link between government debt and interest rates appeared robust across a range of tests.

The link between interest rates and real activity is also open to some debate. The direct linh in the model simulation results presented above are via private investment. The empirical links between interest rate and investment are mixed. In an early survey Jorgensen (1971) found a link between the two via the cost of capital. However more recent surveys by Clark (1979) and Chirinko (1991) find the cost of capital to be relatively insignificant determinant of private investnent. These studies of the link between the cost of capital and investment all suffer frm the problem of measuring the relevant variables. For example, problems of calculating expected inflation for calculating real interest rates as well as problems of capturing tax effects are large. Other empirical studies that have couched the impact of interest rates through Tobin's Q have also met with little success. Even these studies have floundered on the problem of relating the available data to the relevant economic concept The one area where the empirical evidence of investment is giving positive results is in the cash flow theory of investment. A number of recent authors have found empirical support at the macroeconomic and individual firn level that the availability of funds widhin the finm is an empincally important determiant of investment (see for example Fazzari (1993), Fazzari, Hubbard and Petersen (1988)).

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