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Understanding the effects of government spending on consumption

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

Recent evidence on the effect of government spending shocks on consumption 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 (non-Ricardian) 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. JEL Classification: E32, E62

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Paper provided by European Central Bank in its series Working Paper Series with number 0339.

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Date of creation: Apr 2004
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Handle: RePEc:ecb:ecbwps:20040339
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