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Explaining the Effects of Government Spending Shocks


  • Zubairy, Sarah


The objective of this paper is to identify and explain effects of a government spending shock. After accounting for large military events, I find that in response to a structural unanticipated government spending shock, output, hours, consumption and wages all rise, whereas investment falls on impact. I construct and estimate a dynamic general equilibrium model featuring deep habit formation and show that it successfully explains these effects. In particular, deep habits give rise to countercyclical markups and thus act as transmission mechanism for the effects of government spending shocks on private consumption and wages. In addition, I show that deep habits significantly improve the fit of the model compared to a model with habit formation at the level of aggregate goods.

Suggested Citation

  • Zubairy, Sarah, 2010. "Explaining the Effects of Government Spending Shocks," MPRA Paper 26051, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:26051

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    References listed on IDEAS

    1. Burnside, Craig & Eichenbaum, Martin & Fisher, Jonas D. M., 2004. "Fiscal shocks and their consequences," Journal of Economic Theory, Elsevier, vol. 115(1), pages 89-117, March.
    2. Ravn, Morten O & Schmitt-Grohé, Stephanie & Uribe, Martín, 2007. "Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate," CEPR Discussion Papers 6541, C.E.P.R. Discussion Papers.
    3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    4. Morten Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
    5. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1329-1368.
    6. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-334, June.
    7. Hafedh Bouakez & Nooman Rebei, 2007. "Why does private consumption rise after a government spending shock?," Canadian Journal of Economics, Canadian Economics Association, vol. 40(3), pages 954-979, August.
    8. Florin O. Bilbiie, 2009. "Nonseparable Preferences, Fiscal Policy Puzzles, and Inferior Goods," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2-3), pages 443-450, March.
    9. Chernozhukov, Victor & Hong, Han, 2003. "An MCMC approach to classical estimation," Journal of Econometrics, Elsevier, vol. 115(2), pages 293-346, August.
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    Cited by:

    1. Cloyne, James S, 2011. "Government spending shocks, wealth effects and distortionary taxes," MPRA Paper 41689, University Library of Munich, Germany.
    2. Leith, Campbell & Moldovan, Ioana & Rossi, Raffaele, 2015. "Monetary and fiscal policy under deep habits," Journal of Economic Dynamics and Control, Elsevier, vol. 52(C), pages 55-74.
    3. Hashmat Khan & Abeer Reza, 2017. "House Prices and Government Spending Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(6), pages 1247-1271, September.
    4. Zubairy, Sarah, 2010. "Deep Habits, Nominal Rigidities and Interest Rate Rules," MPRA Paper 26053, University Library of Munich, Germany.
    5. Yi, Fujin & Lin, C.-Y. Cynthia & Thome, Karen, 2013. "An Analysis of the Effects of Government Subsidies and the Renewable Fuels Standard on the Fuel Ethanol Industry: A Structural Econometric Model," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 150224, Agricultural and Applied Economics Association.

    More about this item


    deep habits; fiscal shocks; government spending; countercyclical markups;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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