Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets

George-Marios Angeletos () and Vasia Panousi ()

No 13136, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper revisits the macroeconomic effects of government consumption in the neoclassical growth model augmented with idiosyncratic investment (or entrepreneurial) risk. Under complete markets, a permanent increase in government consumption has no long-run effect on the interest rate, the capital-labor ratio, and labor productivity, while it increases work hours due to the familiar negative wealth effect. These results are upset once we allow for incomplete markets. The very same negative wealth effect now causes a reduction in risk taking and investment. This in turn leads to a lower risk-free rate and, under certain conditions, also to a lower capital-labor ratio, lower productivity and lower wages.

JEL-codes: E13 E6 H3 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
Date: 2007-05
Note: EFG PE
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