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

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Author Info
George-Marios Angeletos
Vasia Panousi

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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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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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Find related papers by JEL classification:
E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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  1. Herrera, Santiago & Vincent, Bruno, 2008. "Public expenditure and consumption volatility," Policy Research Working Paper Series 4633, The World Bank. [Downloadable!]
  2. 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. [Downloadable!]
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