Fiscal Policy, Wealth Effects and Markups

Roberto Perotti and Tommaso Monacelli

No 7099, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We document that an increase in government purchases generates a rise in consumption, the real and the product wage, and a fall in the markup. This evidence is robust across alternative empirical methodologies used to identify innovations in government spending (structural VAR vs. narrative approach). Simultaneously accounting for these facts is a formidable challenge for a neoclassical model, which relies on the wealth effect on labor supply as the main channel of transmission of unproductive government spending shocks. The goal of this paper is to explore further the role of the wealth effect in the transmission of government spending shocks. To this end, we build an otherwise standard business cycle model with price rigidity, in which preferences can be consistent with an arbitrarily small wealth effect on labor supply, and highlight that such effect is linked to the degree of complementarity between consumption and hours. The model is able to match our empirical evidence on the effects of government spending shocks remarkably well. This happens when the preferences are such that the positive wealth effect on labor supply is small and therefore the negative wealth effect on consumption is, somewhat counterintuitively, large.

Keywords: Government spending; Markup; Private consumption; Wealth effect (search for similar items in EconPapers)
JEL-codes: D91 E21 E62 (search for similar items in EconPapers)
Date: 2008-12
New Economics Papers: this item is included in nep-cba and nep-mac
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Citations: View citations in EconPapers (155)

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Working Paper: Fiscal Policy, Wealth Effects, and Markups (2008)
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