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Why Does Private Consumption Rise After a Government Spending Shock?

  • Nooman Rebei
  • Hafedh Bouakez

Recent empirical evidence suggests that private consumption is crowded-in by government spending. This outcome violates existing macroeconomic theory, according to which the negative wealth effect brought about by a rise in public expenditure should decrease consumption. In this paper, we develop a simple real business cycle model where preferences depend on private and public spending, and households are habit forming. The model is estimated by the minimum-distance and the maximum-likelihood methods using U.S. data. Estimation results indicate a strong Edgeworth complementarity between private and public spending. This feature enables the model to generate a positive response of consumption following a government spending shock. In addition, the impulse-response functions generated by the estimated model mimic closely those obtained from a benchmark vector autoregression

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 20.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:20
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  29. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
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