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Assessing the impact of a change in the composition of public spending: a DSGE approach

  • Straub, Roland
  • Tchakarov, Ivan

Despite intense calls for safeguarding public investment in Europe, public investment expenditure, when measured in relation to GDP, has steadily fallen in the last three decades, evoking fears that economic activity may be correspondingly negatively affected. At the same time, however, public consumption in the EU-12 countries has trended up. In this paper, we provide a macroeconomic assessment of the observed change in the composition of public spending in the euro area in a medium-scale two-country dynamic stochastic general equilibrium (DSGE) model. First, we analyze the channels through which, both temporary and permanent public investment shocks generate larger fiscal multipliers than exogenous increases in public consumption. Furthermore, we quantify the negative impact of a change in fiscal stance, characterized by a permanent rise in public consumption and a permanent fall in public investment, keeping thereby the overall level of public spending constant. The key message of the paper is that calls for reversing the observed trend in the composition of public spending are well justifed. JEL Classification: F41, F42

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Paper provided by European Central Bank in its series Working Paper Series with number 0795.

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Date of creation: Aug 2007
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Handle: RePEc:ecb:ecbwps:20070795
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  1. Galí, Jordi & López-Salido, David & Vallés, Javier, 2004. "Understanding the effects of government spending on consumption," Working Paper Series 0339, European Central Bank.
  2. William Easterly & Sergio Rebelo, 1993. "Fiscal Policy and Economic Growth: An Empirical Investigation," NBER Working Papers 4499, National Bureau of Economic Research, Inc.
  3. Douglas Laxton & Michael Kumhof, 2007. "A Party without a Hangover? On the Effects of U.S. Government Deficits," 2007 Meeting Papers 676, Society for Economic Dynamics.
  4. Coenen, Günter & McAdam, Peter & Straub, Roland, 2008. "Tax reform and labour-market performance in the euro area: A simulation-based analysis using the New Area-Wide Model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2543-2583, August.
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  12. David Aschauer, 1988. "Is public expenditure productive?," Staff Memoranda 88-7, Federal Reserve Bank of Chicago.
  13. Florin O. Bilbiie & Roland Straub, 2004. "Fiscal Policy, Business Cycles and Labor-Market Fluctuations," MNB Working Papers 2004/6, Magyar Nemzeti Bank (Central Bank of Hungary).
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  15. David Alan Aschauer, 1989. "Public investment and productivity growth in the Group of Seven," Economic Perspectives, Federal Reserve Bank of Chicago, issue Sep, pages 17-25.
  16. Valila, Timo & Mehrotra, Aaron, 2005. "Evolution And Determinants Of Public Investment In Europe," Economic and Financial Reports 2005/1, European Investment Bank, Economics Department.
  17. Jakob Haan & Jan Sturm & Bernd Sikken, 1996. "Government capital formation: Explaining the decline," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 132(1), pages 55-74, March.
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  19. Gramlich, Edward M, 1994. "Infrastructure Investment: A Review Essay," Journal of Economic Literature, American Economic Association, vol. 32(3), pages 1176-96, September.
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