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Productive Government Expenditure in a Stochastically Growing Economy

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  • Stephen Turnovsky

Abstract

This paper analyzes productive government expenditure in a stochasticAK growth model. First, a centrally planned economy is characterized,emphasizing the trade-off between the effects of both deterministicand stochastic government expenditures on the equilibrium growth rateand its variance. Both the growth-maximizing and thewelfare-maximizing shares of government expenditure are derived andshown to depend (differentially) upon the degree of risk in theeconomy. Whereas production risk reduces the welfare-maximizingshare of government expenditure, it may either increase or decreasethe growth-maximizing share, depending upon the degree of riskaversion. Next, the stochastic equilibrium in a decentralized economyis derived. The first-best optimal tax structure is characterized andits dependence on risk is determined. The formal analysis issupplemented by some numerical simulations to assess the quantitativesignificance of risk and the divergence that this generates between thewelfare-maximizing and growth-maximizing size of government.

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Bibliographic Info

Paper provided by University of Washington, Department of Economics in its series Working Papers with number 0056.

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Date of creation: Sep 1998
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Handle: RePEc:udb:wpaper:0056

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  1. Grinols, Earl L. & Turnovsky, Stephen J., 1993. "Risk, the financial market, and macroeconomic equilibrium," Journal of Economic Dynamics and Control, Elsevier, vol. 17(1-2), pages 1-36.
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