Government spending shocks, wealth effects and distortionary taxes

James Cloyne

MPRA Paper from University Library of Munich, Germany

Abstract: This paper investigates the transmission mechanism of government spending shocks in an estimated dynamic general equilibrium model. I construct a New Keynesian model with distortionary labour and capital taxes and with references that allow the wealth effect on labour supply to vary in strength. I show that the interaction of these two features crucially affects the response of the economy to a government spending shock. The model's parameters are therefore estimated (including the tax policy rules) for the United States. I show that the estimated model can match the positive empirical response of key variables including output, consumption and the real wage - a challenge for many New Keynesian models. I find that the estimated importance of the wealth effect is small; that sticky prices, variable capital utilisation, investment adjustment costs and habits all play an important role; and that whilst tax rates rise following the shock, their small magnitude crucially reduces the distortions involved.

Keywords: fiscal policy; government spending shocks; government spending multiplier; business cycles (search for similar items in EconPapers)
JEL-codes: E20 E32 E62 H20 N10 (search for similar items in EconPapers)
Date: 2011-07-06
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Government spending shocks, wealth effects and distortionary taxes (2014)
Working Paper: Government spending shocks, wealth effects and distortionary taxes (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:41689

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