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The Effects of Public Spending Externalities

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  • Valerio Ercolani
  • João Valle e Azevedo

Abstract

We take to the data an RBC model with two salient features. First, we allow government consumption to directly affect the marginal utility of consumption. Second, we allow public capital to affect the productivity of private factors. On the one hand, private and government consumption are estimated to be substitute goods. As a consequence, the estimated response of private consumption to a government consumption shock is negative, as in models with separable government consumption, but such response is much stronger. Further, substitutability makes labor supply to react less, so the estimated output multiplier is lower than in models with separabilities, peaking - on impact - at 0.39. On the other hand, non-defense public investment enhances mildly or negligibly, depending on the specification, the productivity of private factors. In those specifications where non-defense public investment is found to be productive, a non-defense investment shock generates the following estimated responses (after several quarters): a positive reaction for private consumption, Tobin’s q, private investment and real wages. Unlike models with unproductive government investment, the estimated output multiplier builds up over time, starting well below one on impact, then reaching 0.93 after three years and 1.44 after six.

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Bibliographic Info

Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w201210.

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Date of creation: 2012
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Handle: RePEc:ptu:wpaper:w201210

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  1. Eric M. Leeper, Todd B. Walker, And Shu-Chun S. Yang, 2009. "Government Investment And Fiscal Stimulus In The Short And Long Runs," Caepr Working Papers 2009-011, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  2. Shu-Chun S. Yang & Todd B. Walker & Eric M. Leeper, 2010. "Government Investment and Fiscal Stimulus," IMF Working Papers 10/229, International Monetary Fund.
  3. Leeper, Eric M. & Plante, Michael & Traum, Nora, 2010. "Dynamics of fiscal financing in the United States," Journal of Econometrics, Elsevier, vol. 156(2), pages 304-321, June.
  4. Fiorito, Riccardo & Kollintzas, Tryphon, 2004. "Public goods, merit goods, and the relation between private and government consumption," European Economic Review, Elsevier, vol. 48(6), pages 1367-1398, December.
  5. Robert A. Amano & Tony S. Wirjanto, 1998. "Government Expenditures and the Permanent-Income Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 719-730, July.
  6. John A. Tatom, 1991. "Public capital and private sector performance," Review, Federal Reserve Bank of St. Louis, issue May, pages 3-15.
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Cited by:
  1. João Valle e Azevedo & Valerio Ercolani, 2012. "An evaluation of government expenditures’ externalities," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
  2. Valerio Ercolani & João Valle e Azevedo, 2013. "The Output Effects of (Non-Separable) Government Consumption at the Zero Lower Bound," Working Papers w201310, Banco de Portugal, Economics and Research Department.

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