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Why Does Private Consumption Rise After a Government Spending Shock?

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  • Hafedh Bouakez
  • Nooman Rebei

Abstract

Recent empirical evidence suggests that private consumption is crowded-in by government spending. This outcome violates existing macroeconomic theory, according to which the negative wealth effect brought about by a rise in public expenditure should decrease consumption. In this paper, we develop a simple real business cycle model where preferences depend on private and public spending, and households are habit forming. The model is estimated by the minimumdistance and the maximum-likelihood methods using U.S. data. Estimation results indicate a strong Edgeworth complementarity between private and public spending. This feature enables the model to generate a positive response of consumption following a government spending shock. In addition, the impulse-response functions generated by the estimated model mimic closely those obtained from a benchmark vector autoregression.

Suggested Citation

  • Hafedh Bouakez & Nooman Rebei, 2003. "Why Does Private Consumption Rise After a Government Spending Shock?," Staff Working Papers 03-43, Bank of Canada.
  • Handle: RePEc:bca:bocawp:03-43
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    References listed on IDEAS

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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