Risk, productive government expenditure, and the world economy
This paper analyzes the expenditure policy of the public sector and risk in a two-country stochastic AK growth model, provided that public spending is productivity- and volatility-enhancing. First we derive the world macroeconomic equilibrium. Then we study the impact of changes in exogenous variables on consumption, growth, and welfare. Next, we show that consumption-wealth ratio and welfare should be higher in an open economy than in a closed economy. We discuss whether open economies grow more than closed economies. Then the optimal size of the public sector is derived in two different scenarios in an open economy. We get that the size of the public sector which maximizes welfare is lower than that which maximizes growth. Finally, we analyze whether more open economies are associated with a higher optimal size of the public sector. The optimal size in an open economy can be higher than that in a closed economy for two reasons: different marginal impact of public spending on productivity and risk diversification.
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