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A Pitfall with DSGE-Based, Estimated, Government Spending Multipliers

  • Fève, P.
  • Matheron, J.
  • Sahuc, J.G.

This paper examines issues related to the estimation of the government spending multiplier (GSM) in a Dynamic Stochastic General Equilibrium context. We stress a potential source of bias in the GSM arising from the combination of Edgeworth complementarity/substitutability between private consumption and government expenditures and endogenous government expenditures. Due to cross-equation restrictions, omitting the endogenous component of government policy at the estimation stage would lead an econometrician to underestimate the degree of Edgeworth complementarity and, consequently, the long-run GSM. An estimated version of our model with US postwar data shows that this bias matters quantitatively. The results prove to be robust to a number of perturbations.

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Paper provided by Banque de France in its series Working papers with number 379.

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Length: 59 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:bfr:banfra:379
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