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Why does private consumption rise after a government spending shock?

Author

Listed:
  • Hafedh Bouakez
  • Nooman Rebei
Abstract
Some recent empirical evidence suggests that private consumption is crowded-in by government spending. This outcome violates neoclassical 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 maximum-likelihood method 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 are generally consistent with those obtained from a benchmark vector autoregression.

Suggested Citation

  • 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.
    • Handle: RePEc:cje:issued:v:40:y:2007:i:3:p:954-979
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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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