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Understanding the Effects of Government Spending on Consumption

  • Jordi Galí
  • J. David López-Salido
  • Javier Vallés

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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11578.

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Date of creation: Aug 2005
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Publication status: published as Jordi Galí & J. David López-Salido & Javier Vallés, 2007. "Understanding the Effects of Government Spending on Consumption," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 227-270, 03.
Handle: RePEc:nbr:nberwo:11578
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