Contractionary effects of expansionary fiscal policy: theory and tests

This paper extends the theoretical work of Ahtiala [Eur. Econ. Rev. (1989) 1481] and examines whether the conditions for fiscal expansion to have a contractionary effect on output are met in Canada. A consistent open economy money-demand function yields an income elasticity of the demand for money greater than unity, leading to the theoretical prediction that this is indeed the case. Study of three episodes and an empirical test lend support to the prediction. The United States is predicted to have the conventional response. (C) 2002 Elsevier Science B.V. All rights reserved.