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Deep Habits, Nominal Rigidities and the Response of Consumption to Fiscal Expansions

  • P. JACOB

    ()

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Many empirical studies report that .fiscal expansions have a positive effect on private consumption. This paper provides a closer examination of the .deep. habits mechanism used by Ravn, Schmitt-Grohé and Uribe (2006) to generate the positive comovement between public and private consumption. In their set-up, habit-formation at the level of individual varieties makes the demand function facing the price-setting .firm, dynamic. This makes it optimal for the .firms to lower mark-ups of prices over nominal marginal costs when they expand production in response to the .fiscal expansion, leading to an increase in the demand for labor and hence the real wage rises. The consequent intra-temporal substitution of consumption for leisure triggers the positive response of consumption. Here, we show that increasing either price or nominal wage stickiness, reduces the impact of fiscal spending shocks on the mark-up and the real wage. Hence, consumption is still crowded out as in traditional models.

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File URL: http://wps-feb.ugent.be/Papers/wp_10_641.pdf
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Paper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 10/641.

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Length: 22 pages
Date of creation: Feb 2010
Date of revision:
Handle: RePEc:rug:rugwps:10/641
Contact details of provider: Postal: Hoveniersberg 4, B-9000 Gent
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Web page: http://www.ugent.be/eb

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  1. 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.
  2. Morten O. Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate," NBER Working Papers 13328, National Bureau of Economic Research, Inc.
  3. Morten Ravn & Stephanie Schmitt-Grohé & Mart�n Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
  4. Francesco FURLANETTO, 2007. "Fiscal Shocks and the Consumption Response when Wages are Sticky," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 07.11, Université de Lausanne, Faculté des HEC, DEEP.
  5. Roland Straub & Gert Peersman, 2006. "Putting the New Keynesian Model to a Test," IMF Working Papers 06/135, International Monetary Fund.
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