Understanding the effects of government spending in a time-inconsistent model

Yoonseok Choi and Sunghyun Henry Kim

Economic Modelling, 2021, vol. 98, issue C, 266-279

Abstract: This paper examines the effects of government spending shock in a model that features time inconsistency. We build a time-inconsistency edifice on a standard dynamic stochastic general equilibrium (DSGE) model to explore dynamic behavior of macroeconomic aggregates and present-value multipliers. Comparison of the results from a time-inconsistent model (TIM) and a time-consistent model (TCM) reveals that two models deliver markedly different dynamic responses and multiplier effects. A positive government spending shock in TIM delivers a larger decrease in consumption, a smaller decrease in investment and a larger increase in labor and output than TCM. Impact and long-run fiscal multipliers for output in TIM are around 0.28 and 0.01, respectively, which are larger than those in TCM (0.13 and −0.23). The larger multipliers result from the sophistication effect formed by an individual’s perception of their future selves’ behavior. Various sensitivity analyses on important parameters do not reverse the baseline result.

Keywords: Government spending; Present-value multipliers; Government spending rule; Time-inconsistent preference; Sophistication effect (search for similar items in EconPapers)
JEL-codes: E6 H3 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:98:y:2021:i:c:p:266-279

DOI: 10.1016/j.econmod.2020.11.018

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