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The Effects Of Fiscal Shocks On Consumption: Reconciling Theory And Data

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  • GIOVANNI GANELLI

Recent research has stressed the inconsistency between empirical evidence and the theoretical prediction of both the standard real business cycle and the New Keynesian models regarding the impact of fiscal shocks on consumption. Some authors have attempted to bridge this gap by relying on assumptions about the effects of government spending on preferences and production, or on deviations from the intertemporal optimizing framework. In this paper we follow a different route. We show that introducing at the same time imperfect competition, sticky prices and deviations from Ricardian equivalence through an overlapping generations model helps to solve the inconsistency between theory and data. Our paper can also be seen in the light of the classic controversy between Keynesians and monetarists on the effectiveness of fiscal policy. From this angle, our model can be considered a reincarnation of the classic work of (Journal of Public Economics, Vol. 2 (1973), pp. 319-337). Copyright © 2007 The Author; Journal compilation © 2007 Blackwell Publishing Ltd and The University of Manchester.

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Article provided by University of Manchester in its journal Manchester School.

Volume (Year): 75 (2007)
Issue (Month): 2 (03)
Pages: 193-209

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Handle: RePEc:bla:manchs:v:75:y:2007:i:2:p:193-209
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  1. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-660, June.
  2. Linnemann, Ludger & Schabert, Andreas, 2004. "Can fiscal spending stimulate private consumption?," Economics Letters, Elsevier, vol. 82(2), pages 173-179, February.
  3. Rankin, Neil & Scalera, Domenico, 1995. "Death and the Keynesian multiplier," Ricerche Economiche, Elsevier, vol. 49(1), pages 75-87, March.
  4. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, September.
  5. Ganelli, Giovanni, 2003. "Useful government spending, direct crowding-out and fiscal policy interdependence," Journal of International Money and Finance, Elsevier, vol. 22(1), pages 87-103, February.
  6. Ganelli, Giovanni, 2005. "The new open economy macroeconomics of government debt," Journal of International Economics, Elsevier, vol. 65(1), pages 167-184, January.
  7. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
  8. Fatás, Antonio & Mihov, Ilian, 2001. "The Effects of Fiscal Policy on Consumption and Employment: Theory and Evidence," CEPR Discussion Papers 2760, C.E.P.R. Discussion Papers.
  9. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
  10. Friedman, Milton, 1972. "Comments on the Critics," Journal of Political Economy, University of Chicago Press, vol. 80(5), pages 906-950, Sept.-Oct.
  11. Ludger Linnemann & Andreas Schabert, 2006. "Productive Government Expenditure In Monetary Business Cycle Models," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(1), pages 28-46, 02.
  12. Ganelli, Giovanni, 2007. "Fiscal policy rules in an overlapping generations model with endogenous labour supply," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 1015-1036, March.
  13. Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
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