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Optimal Fiscal Policy over the Business Cycle with Productive Government Infrastructures

Author

Listed:
  • Alessandro Mennuni

    (University of Southampton)

  • Martin Gervais

    (University of Southampton, University of Texas at Austin, IFS)

Abstract

which government infrastructures, which are part of the fiscal policy, are an input into production which firms do not control. We show that if the production of government infrastructures is subject to correlated but less volatile shocks than private production, then a negative productivity shock calls for an immediate increase in government spending on infrastructures mainly financed by government debt. As the shock dies out, debt is reduced both by an increase in taxes and a reduction in spending. We also study the optimal size of fiscal stimuli as we change the variance of productivity in the government sector relative to that of the private sector. Even in the extreme case in which the government sector is immune to productivity shocks, a 2-standard error negative shock to private sector productivity only calls for an increase in government spending equivalent to 2 percent of steady state GDP. The response of government spending decreases as the variance of government productivity increases.

Suggested Citation

  • Alessandro Mennuni & Martin Gervais, 2009. "Optimal Fiscal Policy over the Business Cycle with Productive Government Infrastructures," 2009 Meeting Papers 1153, Society for Economic Dynamics.
    • Handle: RePEc:red:sed009:1153
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