Does the crowding-in effect of public spending on private consumption undermine neoclassical models? |
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| Institution: | 1. Département des sciences économiques, Université du Québec à Montréal, C.D. Howe Institute, Rimini Centre for Economic Analysis, Canada;2. Department of Applied Economics, HEC Montréal, Canada;3. Département de sciences économiques, Université de Montréal, CIREQ, Canada;1. Harvard University, United States;2. Dodge & Cox, United States;1. National Graduate Institute For Policy Studies (GRIPS), Tokyo, Japan;2. Institute of Economics, Academia Sinica, Taiwan;3. Department of Public Finance, National Chengchi University, Taiwan;4. Department of Public Finance, Feng Chia University, Taiwan |
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| Abstract: | Empirical evidence from vector autoregressions (VARs) showing that public spending shocks crowd in private consumption has been seen as evidence against standard neoclassical models of the business cycle. We show that a standard real business cycle model in which all agents including the government optimize is compatible with the results from the empirical literature. A VAR estimated using artificial data simulated from the model indicates that, under standard assumptions to identify public spending shocks, an increase in public spending is associated with an increase in private consumption and the real wage. The implied impulse responses are qualitatively and quantitatively similar to those in the empirical literature. |
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