The Stabilizing Role of Government Size

Rafael Domenech (), Javier Andrés () and Antonio Fatas ()

No 603, Working Papers from International Economics Institute, University of Valencia

Abstract: This paper presents an analysis of how alternative models of the business cycle can replicate the stylized fact that large governments are associated with less volatile economies. Our analysis shows that adding nominal rigidities and costs of capital adjustment to an otherwise standard RBC model can generate a negative correlation between government size and the volatility of output. However, in the model, we find that the stabilizing effect is only due to a composition effect and it is not present when we look at the volatility of private output. Given that empirically we also observe a negative correlation between government size and the volatility of consumption, we modify the model by introducing rule-of-thumb consumers. In this modified version of our initial model we observe that consumption volatility is also reduced when government size increases in similar way to the observed pattern in OECD economies over the last 45 years.

Keywords: Government size; output volatility; automatic stabilizers. (search for similar items in EconPapers)
JEL-codes: E32 E52 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
Date: 2006-10, Revised 2007-01
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http://iei.uv.es/docs/wp_internos/RePEc/pdf/iei_0603.pdf First version, 2006 (application/pdf)
http://iei.uv.es/docs/wp_internos/RePEc/pdf/iei_0603R.pdf Revised version, 2007 (application/pdf)

Related works:
Working Paper: The stabilizing role of government size (2007)
Working Paper: The Stabilizing Role of Government Size (2004)
Journal Article: The stabilizing role of government size (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:iei:wpaper:0603

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