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Productive Government Expenditure in Monetary Business Cycle Models

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Author Info
Ludger Linnemann () (University of Cologne)
Andreas Schabert () (Faculty of Economics and Econometrics, Universiteit van Amsterdam)

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Abstract

This paper assesses the transmission of fiscal policy shocks in a New Keynesian framework where government expenditures contribute to aggregate production. It is shown that even if the impact of government expenditures on production is small, this assumption helps to reconcile the models' predictions about fiscal policy effects with recent empirical evidence. In particular, it is shown that government expenditures can cause a rise in private consumption, real wages, and employment if the government share is not too large and public finance does not solely rely on distortionary taxation. When government expenditures are partially financed by public debt, unit labor costs fall in response to a fiscal expansion, such that inflation tends to decline. Households are willing to raise consumption if monetary policy is active, i.e. ensures that the real interest rate rises with inflation. Otherwise, private consumption can also be crowded-out, as in the conventional case where government expenditures are not productive. The interaction between monetary and fiscal policy is thus decisive for the short-run macroeconomic effects of government expenditure shocks.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-053/2.

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Date of creation: 30 May 2005
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Handle: RePEc:dgr:uvatin:20050053

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Related research
Keywords: Productive government expenditures; private consumption; distortionary taxation; monetary and fiscal policy interaction;

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Find related papers by JEL classification:
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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  1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  2. Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics. [Downloadable!]
    Other versions:
  3. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  4. Turnovsky, Stephen J. & Fisher, Walter H., 1995. "The composition of government expenditure and its consequences for macroeconomic performance," Journal of Economic Dynamics and Control, Elsevier, vol. 19(4), pages 747-786, May. [Downloadable!] (restricted)
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  6. Aschauer, David Alan, 1989. "Is public expenditure productive?," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 177-200, March. [Downloadable!] (restricted)
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  7. Fisher, Walter H & Turnovsky, Stephen J, 1998. "Public Investment, Congestion, and Private Capital Accumulation," Economic Journal, Royal Economic Society, vol. 108(447), pages 399-413, March. [Downloadable!] (restricted)
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  10. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Operational Monetary Policy in the Christiano-Eichenbaum-Evans Model of the U.S. Business Cycle," NBER Working Papers 10724, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October. [Downloadable!] (restricted)
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  13. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  14. Campbell, John Y., 1994. "Inspecting the mechanism: An analytical approach to the stochastic growth model," Journal of Monetary Economics, Elsevier, vol. 33(3), pages 463-506, June. [Downloadable!] (restricted)
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  15. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  16. Olivier Blanchard & Roberto Perotti, 1999. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," NBER Working Papers 7269, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Gramlich, Edward M, 1994. "Infrastructure Investment: A Review Essay," Journal of Economic Literature, American Economic Association, vol. 32(3), pages 1176-96, September. [Downloadable!] (restricted)
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  19. Ludvigson, Sydney, 1996. "The macroeconomic effects of government debt in a stochastic growth model," Journal of Monetary Economics, Elsevier, vol. 38(1), pages 25-45, August. [Downloadable!] (restricted)
  20. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Francesco FURLANETTO, 2007. "Fiscal Shocks and the Consumption Response when Wages are Sticky," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 07.11, Université de Lausanne, Faculté des HEC, DEEP. [Downloadable!]
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