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Understanding the Effects of Government Spending on Consumption

  • Galí, Jordi
  • López-Salido, J David
  • Vallés Liberal, Javier

Recent evidence suggests that consumption rises in response to an increase in government spending. That finding cannot be easily reconciled with existing optimizing business cycle models. We extend the standard new Keynesian model to allow for the presence of rule-of-thumb consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5212.

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Date of creation: Sep 2005
Date of revision:
Handle: RePEc:cpr:ceprdp:5212
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