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The Effect of Public Spending on Consumption: Reconciling Theory and Evidence

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Author Info

  • AMBLER, Steve
  • BOUAKEZ, Hafedh
  • CARDIA, Emanuela

Abstract

Recent empirical evidence from vector autoregressions (VARs) suggests that public spending shocks increase (crowd in) private consumption. Standard general equilibrium models predict the opposite. We show that a standard real business cycle (RBC) model in which public spending is chosen optimally can rationalize the crowding-in effect documented in the VAR literature. When such a model is used as a data-generating process, a VAR estimated using the artificial data yields a positive consumption response to an increase in public spending, consistent with the empirical findings. This result holds regardless of whether private and public purchases are complements or substitutes.

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File URL: http://hdl.handle.net/1866/2579
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Bibliographic Info

Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 2008-11.

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Length: 30 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:mtl:montde:2008-11

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Keywords: Optimal public spending; Business cycles; Crowding in;

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