The Effect of Public Spending on Consumption: Reconciling Theory and Evidence

Steven Ambler (), Hafedh Bouakez and Emanuela Cardia ()

Cahiers de recherche from Universite de Montreal, Departement de sciences economiques

Abstract: Recent empirical evidence from vector autoregressions (VARs) suggests that public spending shocks increase (crowd in) private consumption. Standard general equilibrium models predict the opposite. We show that a standard real business cycle (RBC) model in which public spending is chosen optimally can rationalize the crowding-in effect documented in the VAR literature. When such a model is used as a data-generating process, a VAR estimated using the artificial data yields a positive consumption response to an increase in public spending, consistent with the empirical findings. This result holds regardless of whether private and public purchases are complements or substitutes.

Keywords: Optimal public spending; Business cycles; Crowding in (search for similar items in EconPapers)
JEL-codes: E2 E3 H3 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2008
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http://hdl.handle.net/1866/2579 (application/pdf)

Related works:
Working Paper: The Effect of Public Spending on Consumption: Reconciling Theory and Evidence (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:mtl:montde:2008-11

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