Fiscal policy and private investment in Greece

This paper investigates the effects of fiscal policy on private non-residential investment and output in Greece. Besides examining the direct effects of fiscal consolidation, we investigate the role of financial markets and economic sentiment in the transmission of fiscal policy shocks. A tax based fiscal consolidation has more pronounced and more protracted negative effects on output and private non-residential investment relative to an expenditure based fiscal consolidation. A government spending-based fiscal consolidation improves financial markets and boosts economic sentiment. This in turn mitigates the direct negative effects of fiscal consolidation on private investment and output leading to a more rapid recovery. On the other hand, a tax hike fails to induce this positive confidence effect magnifying the negative effects of fiscal adjustment.