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PRODUCTIVE GOVERNMENT EXPENDITURE IN MONETARY BUSINESS CYCLE MODELS
Author(s) -
Linnemann Ludger,
Schabert Andreas
Publication year - 2006
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/j.1467-9485.2006.00369.x
Subject(s) - economics , consumption (sociology) , inflation (cosmology) , fiscal policy , monetary economics , government debt , monetary policy , business cycle , public finance , aggregate demand , government spending , government (linguistics) , debt , production (economics) , macroeconomics , real interest rate , aggregate expenditure , new keynesian economics , interest rate , market economy , social science , linguistics , philosophy , physics , sociology , theoretical physics , welfare
This paper assesses the transmission of fiscal policy shocks in a New Keynesian framework where government expenditures contribute to aggregate production. It is shown that even if the impact of government expenditures on production is small, this assumption helps to reconcile the models' predictions about fiscal policy effects with recent empirical evidence. In particular, it is shown that government expenditures can lead to a rise in private consumption, real wages, and employment if the government share is not too large and public finance does not solely rely on distortionary taxation. When government expenditures are partially financed by public debt, unit labor costs fall in response to a fiscal expansion, such that inflation tends to decline. Households are willing to raise consumption if monetary policy is active, i.e. ensures that the real interest rate rises with inflation. Otherwise, private consumption can also be crowded out, as in the conventional case where government expenditures are not productive.