Period R:
The latter arguments immediately carry over to period R when the fiscal compensation measures
and/or the accommodating demand-policies have to materialize once the reforms are
implemented. The resulting deterioration in the budget can be classified as indirect (European
Commission, 2005; Annett et al., 2004) since it is a politically necessary and not a technically
inherent part of the reforms.
A further type of indirect consequences can occur through the impact of reforms on the business
cycle. Expectation considerations suggest that there may be immediate expansionary
consequences as early as a government credibly commits itself to reforms. Duval and Elmeskov
(2005) correctly argue that positive long-run supply side effects can lead to an instantaneous
demand reaction. Investors and consumers forming rational expectations may at once increase
spending due to the perception of increasing expected returns and/or life time income. This kind
of expectation effects have been extensively analysed in the context of the so called “non-
Keynesian” effects of fiscal consolidation following the contributions by McDermott and Wescott
(1996) and Alesina and Perotti (1997). The analogy in the context of structural reforms is obvious.
However, depending on the specific type of institutional change and its public perception,
negative demand effects can neither be excluded if the general public is (mistakenly) pessimistic
about the reform consequences45 or if, for example, a decrease of social protection leads to an
increase in precautionary savings (Duval and Elmeskov, 2005).
In addition, the fiscal position in period R is affected by possible direct implications of reforms
(European Commission, 2005). Structural reforms can have immediate budgetary consequences
that may be negative (the mostly cited example are second pillar pension reforms) or positive (e.g.
reforms, which decrease the generosity of existing transfer systems).
It should be stressed that the issue of public perception and immediate expectation effects is of
high policy relevance to the whole reform debate and has so far not attracted sufficient attention in
the empirical literature. To the extent that positive immediate demand effects materialize all
problems related to J-curves and short-run costs would be alleviated.
45 For the US, there is evidence that beliefs of the general public diverge significantly from professional economists’ beliefs on the economic
situation and the relevant drivers of economic performance (Caplan, 2002a).
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