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Sectoral shocks, reallocation frictions, and optimal government spending


  • Rodolfo E. Manuelli
  • Adrian Peralta-Alva


What is the optimal policy response to a negative sectoral shock? How do frictions in goods and labor markets affect the nature and speed of the process of reallocating resources across alternative uses? Should government controlled inputs be allocated to compensate for frictions faced by the private sector or, rather, should they be deployed to complement private sector decisions? In this paper we make a first attempt to understand what features of an economy determine the answers to the previous questions. We study a model in which the drop in the private demand for structures frees up resources that can be used to produce government capital. For a reasonable calibration, we find that government spending increases in response to the drop in private demand, but that the size of the increase is inversely related to the level of frictions: the 1 larger the costs that the economy faces to reallocate resources (capital and labor) across sectors, the smaller the optimal level of government spending.

Suggested Citation

  • Rodolfo E. Manuelli & Adrian Peralta-Alva, 2011. "Sectoral shocks, reallocation frictions, and optimal government spending," Working Papers 2011-017, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2011-017

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    References listed on IDEAS

    1. Jack Favilukis & Sydney C. Ludvigson & Stijn Van Nieuwerburgh, 2017. "The Macroeconomic Effects of Housing Wealth, Housing Finance, and Limited Risk Sharing in General Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 125(1), pages 140-223.
    2. Morris A. Davis, 2010. "housing and the business cycle," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
    3. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, vol. 71(1), pages 1-26, January.
    4. Robert E. Hall, 2009. "By How Much Does GDP Rise If the Government Buys More Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 183-249.
    5. Horvath, Michael, 2000. "Sectoral shocks and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 69-106, February.
    6. Matt Chambers & Carlos Garriga & Don Schlagenhauf, 2009. "The Loan Structure and Housing Tenure Decisions in an Equilibrium Model of Mortgage Choice," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 444-468, July.
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    Cited by:

    1. Boldrin, Michele & Garriga, Carlos & Peralta-Alva, Adrian & Sánchez, Juan M., 2012. "Reconstructing the great recession," Working Papers 2013-006, Federal Reserve Bank of St. Louis, revised 21 Jan 2016.

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    Government spending policy ; Capital ; Labor market;

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