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

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  • P. JACOB

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Abstract

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.

Suggested Citation

  • P. Jacob & -, 2010. "Deep Habits, Nominal Rigidities and the Response of Consumption to Fiscal Expansions," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 10/641, Ghent University, Faculty of Economics and Business Administration.
  • Handle: RePEc:rug:rugwps:10/641
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    File URL: http://wps-feb.ugent.be/Papers/wp_10_641.pdf
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    References listed on IDEAS

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    1. Günter Coenen & Roland Straub, 2005. "Does Government Spending Crowd in Private Consumption? Theory and Empirical Evidence for the Euro Area," International Finance, Wiley Blackwell, vol. 8(3), pages 435-470, December.
    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. Morten Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
    4. 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.
    5. 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.
    6. 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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    Cited by:

    1. Cristiano Cantore & Paul Levine & Giovanni Melina, 2014. "A Fiscal Stimulus and Jobless Recovery," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(3), pages 669-701, July.
    2. Furlanetto, Francesco, 2011. "Fiscal stimulus and the role of wage rigidity," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 512-527, April.
    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. Giovanni Melina & Stefania Villa, 2014. "Fiscal Policy And Lending Relationships," Economic Inquiry, Western Economic Association International, vol. 52(2), pages 696-712, April.

    More about this item

    Keywords

    Deep Habits; Sticky Prices; Sticky Wages; Fiscal Shocks; Crowding-out.;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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