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Revisiting the Supply-Side Effects of Government Spending

George-Marios Angeletos

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Vasia Panousi

Federal Reserve Board

January 2009

FEDS Working Paper No. 2009-01

We revisit the macroeconomic effects of government consumption in the neoclassical growth model when agents face uninsured idiosyncratic investment risk. Under complete markets, a permanent increase in government consumption has no long-run effect on the interest rate and the capital-labor ratio, while it increases hours due to the negative wealth effect. These results are upset once we allow for incomplete markets. The same negative wealth effect now causes a reduction in risk taking and the demand for investment. This leads to a lower risk-free rate and, under certain conditions, also to a lower capital-labor ratio, and lower productivity.

Number of Pages in PDF File: 47

Keywords: Fiscal policy, government spending, incomplete risk sharing, entrepreneurial risk

JEL Classification: E13, E62

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Date posted: April 6, 2009  

Suggested Citation

Angeletos, George-Marios and Panousi, Vasia, Revisiting the Supply-Side Effects of Government Spending (January 2009). FEDS Working Paper No. 2009-01. Available at SSRN: http://ssrn.com/abstract=1370451 or http://dx.doi.org/10.2139/ssrn.1370451

Contact Information

George-Marios Angeletos
Massachusetts Institute of Technology (MIT) - Department of Economics ( email )
50 Memorial Drive
Room E52-251b
Cambridge, MA 02142
United States
617-452-3859 (Phone)
617-253-1330 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Vasia Panousi (Contact Author)
Federal Reserve Board ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
HOME PAGE: http://www.federalreserve.gov/research/staff/panousivasiax.htm
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