Resolving the Fiscal Price Puzzle: General Equilibrium Effects and the Composition of Government Spending

Sangyup Choi and Kyung Woong Koh
Additional contact information
Sangyup Choi: Yonsei University

No 2026rwp-280, Working papers from Yonsei University, Yonsei Economics Research Institute

Abstract: Does government spending raise prices? While standard models predict an inflationary effect, empirical findings are mixed-a puzzle known as the "fiscal price puzzle." We argue that this puzzle reflects differences in aggregation rather than a failure of standard demand transmission. Using newly constructed U.S. MSA-level federal procurement data from 1989-2023 and a shift-share IV strategy, we show that regional fiscal shocks raise local consumer prices when aggregate forces are absorbed through time fixed effects. When aggregate conditions are allowed to respond endogenously, however, the same shocks generate attenuated or even negative price responses. To interpret these findings, we develop a two-region New Keynesian model with centralized monetary policy. Local fiscal expansions increase regional prices but induce union-wide monetary responses that dampen aggregate inflation. Extending the model to consumption and investment sectors, we show that government consumption shocks raise regional and sectoral prices more than investment shocks, yet can produce smaller aggregate price effects due to stronger monetary feedback. Our results highlight how general equilibrium mechanisms and spending composition jointly shape fiscal inflation dynamics.

Keywords: Fiscal price puzzle; Government spending; Spending composition; Military procurement; Monetary union; Shift-share instrument (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E62 F33 (search for similar items in EconPapers)
Pages: 58pages
Date: 2026-02
References: Add references at CitEc
Citations:

Downloads: (external link)
http://121.254.254.220/repec/yon/wpaper/2026rwp-280.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:yon:wpaper:2026rwp-280

Access Statistics for this paper

More papers in Working papers from Yonsei University, Yonsei Economics Research Institute Contact information at EDIRC.
Bibliographic data for series maintained by YERI ().