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Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets

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  • George-Marios Angeletos
  • Vasia Panousi

Abstract

This paper revisits the macroeconomic effects of government consumption in the neoclassical growth model augmented with idiosyncratic investment (or entrepreneurial) risk. Under complete markets, a permanent increase in government consumption has no long-run effect on the interest rate, the capital-labor ratio, and labor productivity, while it increases work hours due to the familiar negative wealth effect. These results are upset once we allow for incomplete markets. The very same negative wealth effect now causes a reduction in risk taking and investment. This in turn leads to a lower risk-free rate and, under certain conditions, also to a lower capital-labor ratio, lower productivity and lower wages.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13136.

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Date of creation: May 2007
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Handle: RePEc:nbr:nberwo:13136

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  1. William M. Gentry & R. Glenn Hubbard, 2000. "Entrepreneurship and Household Saving," NBER Working Papers 7894, National Bureau of Economic Research, Inc.
  2. Francisco Covas, 2005. "Uninsured Idiosyncratic Production Risk with Borrowing Constraints," Working Papers 05-26, Bank of Canada.
  3. Annette Vissing-J�rgensen & Orazio P. Attanasio, 2003. "Stock-Market Participation, Intertemporal Substitution, and Risk-Aversion," American Economic Review, American Economic Association, vol. 93(2), pages 383-391, May.
  4. repec:fth:harver:1466 is not listed on IDEAS
  5. Marco Cagetti & Mariacristina De Nardi, 2006. "Entrepreneurship, Frictions, and Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(5), pages 835-870, October.
  6. Vincenzo Quadrini, 2000. "Entrepreneurship, Saving and Social Mobility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 1-40, January.
  7. King, R.G. & Baxter, M., 1990. "Fiscal Policy In General Equilibrium," RCER Working Papers 244, University of Rochester - Center for Economic Research (RCER).
  8. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  9. George-Marios Angeletos & Laurent Calvet, 2003. "Idiosyncratic Production Risk, Growth, and the Business Cycle," NBER Working Papers 9764, National Bureau of Economic Research, Inc.
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Cited by:
  1. Edouard Challe & Xavier Ragot, 2007. "Public spending shocks in a liquidity-constrained economy," PSE Working Papers halshs-00587686, HAL.
  2. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
  3. Herrera, Santiago & Vincent, Bruno, 2008. "Public expenditure and consumption volatility," Policy Research Working Paper Series 4633, The World Bank.
  4. Kenza Benhima, 2008. "A Reappraisal of the Allocation Puzzle through the Portfolio Approach," EconomiX Working Papers 2008-27, University of Paris West - Nanterre la Défense, EconomiX.
  5. Edouard Challe & Xavier Ragot, 2007. "Public spending shocks in a liquidity-constrained economy," Working Papers halshs-00587686, HAL.
  6. Ragot, Xavier & Challe, Edouard, 2008. "Public Spending Shocks in a Liquidity Constrained Economy," Economics Papers from University Paris Dauphine 123456789/4075, Paris Dauphine University.

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