Fiscal Policy and Private Consumption-Saving Decisions: Evidence from Nine EU Countries

Abstract

This paper considers the effects of fiscal policy on private consumption in a framework that encompasses both the conventional (Keynesian) view of fiscal policy and the Ricardian debt neutrality hypothesis. The model is built on Blanchard's stochastic model of intertemporal optimization with finitely lived consumers. As an extension to the basic framework, the model also nests various hypotheses concerning the relationship between public spending and private consumption. Empirical analyses are based on annual data from nine EU countries covering the years 1961–1994 and use the nonlinear instrumental variable GMM estimator both in country-specific and in panel estimations. The tests cannot reject the hypothesis that consumers are Ricardian except for one country. Moreover, the results suggest that in the consumers' utility functions, government consumption tends to be a complement rather than a substitute for private consumption.private consumption; private saving; fiscal policy; planning horizon