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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.

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File URL: http://www.nber.org/papers/w13136.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13136.

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Date of creation: May 2007
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Publication status: published as Angeletos, George-Marios & Panousi, Vasia, 2009. "Revisiting the supply side effects of government spending," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 137-153, March.
Handle: RePEc:nbr:nberwo:13136
Note: EFG PE
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  1. Robert G. King & Sergio Rebelo, 1990. "Public Policy and Economic Growth: Developing Neoclassical Implications," NBER Working Papers 3338, National Bureau of Economic Research, Inc.
  2. repec:fth:prinin:269 is not listed on IDEAS
  3. Francisco Covas, 2005. "Uninsured Idiosyncratic Production Risk With Borrowing Constraints," Computing in Economics and Finance 2005 198, Society for Computational Economics.
  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. 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 1059-85, December.
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