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Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets


  • George-Marios Angeletos
  • Vasia Panousi


This paper revisits the macroeconomic effects of government consumption in the neoclassical growth model augmented with idiosyncratic investment (or entrepreneurial) risk. Under complete markets, a permanent increase in government consumption has no long-run effect on the interest rate, the capital-labor ratio, and labor productivity, while it increases work hours due to the familiar negative wealth effect. These results are upset once we allow for incomplete markets. The very same negative wealth effect now causes a reduction in risk taking and investment. This in turn leads to a lower risk-free rate and, under certain conditions, also to a lower capital-labor ratio, lower productivity and lower wages.

Suggested Citation

  • George-Marios Angeletos & Vasia Panousi, 2007. "Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets," NBER Working Papers 13136, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13136
    Note: EFG PE

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    References listed on IDEAS

    1. Covas, Francisco, 2006. "Uninsured idiosyncratic production risk with borrowing constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2167-2190, November.
    2. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-1085, December.
    3. King, Robert G & Rebelo, Sergio, 1990. "Public Policy and Economic Growth: Developing Neoclassical Implications," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 126-150, October.
    4. Huggett, Mark, 1997. "The one-sector growth model with idiosyncratic shocks: Steady states and dynamics," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 385-403, August.
    5. repec:fth:prinin:269 is not listed on IDEAS
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    Cited by:

    1. Benhima, Kenza, 2013. "A reappraisal of the allocation puzzle through the portfolio approach," Journal of International Economics, Elsevier, vol. 89(2), pages 331-346.
    2. repec:dau:papers:123456789/4075 is not listed on IDEAS
    3. Edouard Challe & Xavier Ragot, 2007. "Public spending shocks in a liquidity-constrained economy," PSE Working Papers halshs-00587686, HAL.
    4. Vasia Panousi, 2008. "Capital Taxation with Entrepreneurial Risk," 2008 Meeting Papers 36, Society for Economic Dynamics.
    5. Herrera, Santiago & Vincent, Bruno, 2008. "Public expenditure and consumption volatility," Policy Research Working Paper Series 4633, The World Bank.
    6. Catarina Reis & Vasia Panousi, 2016. "A unified framework for optimal taxation with undiversifiable risk," 2016 Meeting Papers 951, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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