Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate

Morten Ravn, Stephanie Schmitt-Grohe and Martín Uribe ()

No 13328, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Using panel structural VAR analysis and quarterly data from four industrialized countries, we document that an increase in government purchases leads to an expansion in output and private consumption, a deterioration in the trade balance, and a depreciation of the real exchange rate (i.e., a decrease in the domestic CPI relative to the exchange-rate adjusted foreign CPI). We propose an explanation for these observed effects based on the deep habit mechanism. We estimate the key parameters of the deep-habit model employing a limited information approach. The predictions of the estimated deep-habit model fit well the observed responses of output, consumption, the trade balance, and the real exchange rate to an unanticipated government spending shock. In addition, the deep-habit model predicts that in response to an anticipated increase in government spending consumption and wages fail to increase on impact, which is consistent with the empirical evidence stemming from the narrative identification approach. In this way, the deep-habit model reconciles the findings of the SVAR and narrative literatures on the effects of government spending shocks.

JEL-codes: E32 E6 F41 (search for similar items in EconPapers)
Date: 2007-08
New Economics Papers: this item is included in nep-cba and nep-mac
Note: EFG IFM
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Citations: View citations in EconPapers (115)

Published as Journal of Monetary Economics Volume 59, Issue 3, April 2012, Pages 215–234

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Working Paper: Explaining the Effects of Government Spending Shocks on Consumption and the Real Exchange Rate (2007)
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