Building on fiscal policy: government consumption and the residential sector. When helping hurts

Increased public spending to combat an economic recession caused by a housing demand shock can significantly harm investment and employment in the housing sector, despite its positive effect on GDP. In terms of the extent of this decoupling between output at the aggregate level and in the housing sector, we find that the easier it is to reallocate employment between production sectors, the lower the reaction of hours worked to wages, and the higher the level of household indebtedness, the more pronounced the decoupling is. Using a Dynamic General Equilibrium model that incorporates a housing construction sector, we find that fiscal stimulus causes an increase in the production of tradable goods that incentivizes the demand for labor and capital, leading to higher wages, which pulls workers out of the construction sector and negatively affects residential investment and total credit. The result is a widespread welfare loss that especially hurts borrowers. Our study offers different possible explanations for the lack of consensus in the empirical evidence on the effects of fiscal policy on the construction sector.