THE EXPANSIONARY FISCAL CONTRACTION HYPOTHESIS - A NEO-KEYNESIAN ANALYSIS

It has recently been argued that several fiscal contractions can, thro ugh their impact on expectations, lead to growth in consumption, inves tment and employment. Since such contractions typically occur because adjustment has been delayed due to fear of aggravating unemployment, w e examine the hypothesis in a model with wage/price rigidities. The Ne w Classical features of the model, however, allow expectational effect s to be taken fully into account. While consumption and investment may rise, we find that employment is in ail cases likely to fall; this le ads us to believe that the so-called 'German view' is overoptimistic.