The Irish expansionary fiscal contraction: A tale from one small European economy

Irish experience during a recent period of severe fiscal adjustment attracted international attention and was claimed to demonstrate an expansionary fiscal contraction. Using a small structural model which fits the stylized facts, we question the extent to which analysis provides convincing evidence in favour of the EFC hypothesis. Our model identifies mechanisms through which fiscal policy operates in SOEs, and incorporates model-consistent expectations. Simulations suggest that the introduction of rational expectations moderates the contractionary effects of public expenditure cuts, but is unlikely to remove them entirely. An alternative explanation of Ireland's positive growth experience is proposed, based largely upon external factors.