The Effect of Government Spending on Private Consumption: A Puzzle?

Abstract

The empirical finding that cyclical changes in government spending tend to be associated with positive responses of private consumption has been interpreted as a challenge for representative agent intertemporal optimizing theories, which usually imply that the negative wealth effect of higher fiscal spending reduces the households' consumption and leisure. The present paper shows that the evidence can be explained by a standard real business cycle type model. With a nonadditively separable utility function and a small intertemporal consumption elasticity, higher fiscal spending can raise consumption and lower investment, as in the data. The nonseparable utility model is shown to imply the same consumption Euler equation as a model with "rule-of-thumb" consumers who mechanically spend their income.

Cite this work

No public copy is stored for this record, so only the metadata is cited.

Stored only when both papers are in the corpus — 134 citations exist upstream.

Papers that cite the same references — the relational fallback while embeddings are still backfilling.