Government spending shocks, wealth effects and distortionary taxes

James Cloyne

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: The size and sign of the government spending multiplier crucially depends on how the spending is financed and how consumers respond to implied future tax increases. I investigate this issue in an estimated New Keynesian DSGE model with distortionary labor and capital taxes and, importantly, with preferences that allow the wealth effect on labor supply to vary. Specifically I assess whether the model can explain the empirical evidence for the United States and examine the transmission mechanism, for realistic policy rules. I show that the model can match the positive empirical response of key variables including output, consumption and the real wage. I find that the role of the wealth effect on labor supply is small and that while tax rates rise following a spending shock these increases are modest, with debt rising. Deficit financed spending increases are therefore expansionary, but this is due to sticky prices rather than the wealth effect channel.

Keywords: fiscal policy; government spending shocks; spending multiplier; busyness cycles (search for similar items in EconPapers)
JEL-codes: E20 E32 E62 H20 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2014-05
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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http://eprints.lse.ac.uk/58024/ Open access version. (application/pdf)

Related works:
Working Paper: Government spending shocks, wealth effects and distortionary taxes (2014)
Working Paper: Government spending shocks, wealth effects and distortionary taxes (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:58024

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