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Risk, utility-enhancing government expenditure, and the world economy

Author

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  • Inaki Erauskin-Iurrita

    (University of Deusto San Sebastian)

Abstract

This paper analyzes the influence of risk and the expenditure policy of the public sector in a two-country stochastic AK growth model where public spending is utility-enhancing. Having characterized the macroeconomic equilibrium first we study the impact of risk and the public sector on consumption-wealth ratio, growth and welfare, given the exogenous size of the public sector. A higher weight of public consumption in the utility function raises the rate of growth due to a fall in the consumption-wealth ratio. Then we show that consumptionwealth ratio and welfare are higher in an open economy than in a closed economy and we study whether open economies grow more than closed economies. Next, the welfare-maximizing size of the public sector is derived and compared it to the size that maximizes growth. We analyze the impact of exogenous parameters, risk specially, on the optimal size. Then we establish that a higher weight of public consumption in the utility function reduces private consumption-wealth ratio leaving the rate of growth unchanged when the size of the public sector is optimally chosen. Finally, we show that more open economies should have a higher size of the public sector under more general conditions than those established in Turnovsky (1999).

Suggested Citation

  • Inaki Erauskin-Iurrita, 2004. "Risk, utility-enhancing government expenditure, and the world economy," International Finance 0412002, EconWPA.
  • Handle: RePEc:wpa:wuwpif:0412002
    Note: Type of Document - pdf; pages: 30
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    References listed on IDEAS

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    1. Jonathan Eaton, 1981. "Fiscal Policy, Inflation and the Accumulation of Risky Capital," Review of Economic Studies, Oxford University Press, vol. 48(3), pages 435-445.
    2. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 103-126, October.
    3. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    4. Corsetti, Giancarlo, 1997. "A portfolio approach to endogenous growth: equilibrium and optimal policy," Journal of Economic Dynamics and Control, Elsevier, vol. 21(10), pages 1627-1644, August.
    5. Robert J. Barro & Xavier Sala-I-Martin, 1992. "Public Finance in Models of Economic Growth," Review of Economic Studies, Oxford University Press, vol. 59(4), pages 645-661.
    6. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    7. Alesina, Alberto & Wacziarg, Romain, 1998. "Openness, country size and government," Journal of Public Economics, Elsevier, vol. 69(3), pages 305-321, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    risk; utility-enhancing government expenditure; consumption; growth; welfare; optimal size of the public sector;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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