THE IMPACT OF FISCAL POLICY ON PRIVATE CONSUMPTION IN ISRAEL WITH EMPHASIS ON THE FISCAL EXPECTATIONS APPROACH

In this paper we assess the impact of fiscal policy on private consumption. We find that there is substitution between private and public consumption but that it is of very limited magnitude (approximately 20 percent). It was also found that, in contrast to the Ricardian approach, the method of financing of public expenditure has an effect on private consumption. Thus, an increase in the direct taxation of wages has a negative effect on consumption that is equal to the full amount of the tax increase while bond financing has a positive effect as long the increase in public debt is small. Evidence was found of the importance of the expectations mechanism with regard to future fiscal developments (the fiscal expectations approach) as manifested in the existence of a public deficit or the channel of its financing: a. The most appropriate variable for testing the degree of substitution between private and public consumption in the long run is public consumption less unilateral transfers from abroad which reduce the public’s burden of financing public expenditure.