Expansionary Fiscal Contraction Hypothesis

Expansionary fiscal contraction can occur under certain assumptions whereby a major reduction in G changes future expectations about taxes and G which leads to an increase in C causing higher GDP if the rise in consumption exceeds the fall in G. This can only happen if government expenditure as a percentage of GDP is reduced significantly to lessen crowding out and allow the private sector to expand. We need to assume that the economy is at full employment for fiscal contraction to be expansionary.

There are three mechanisms for why this may occur: the belief of Ricardian Equivalence, crowding out theory or market sentiments. [...]