Fiscal Policy, Wealth Effects and Markups

Posted: 17 Feb 2009

See all articles by Tommaso Monacelli

Tommaso Monacelli

Bocconi University - Department of Economics

Roberto Perotti

Bocconi University - Department of Economics; European University Institute - Economics Department (ECO); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2008

Abstract

We document that an increase in government purchases generates a rise in consumption, the real and the product wage, and a fall in the markup. This evidence is robust across alternative empirical methodologies used to identify innovations in government spending (structural VAR vs. narrative approach). Simultaneously accounting for these facts is a formidable challenge for a neoclassical model, which relies on the wealth effect on labor supply as the main channel of transmission of unproductive government spending shocks. The goal of this paper is to explore further the role of the wealth effect in the transmission of government spending shocks. To this end, we build an otherwise standard business cycle model with price rigidity, in which preferences can be consistent with an arbitrarily small wealth effect on labor supply, and highlight that such effect is linked to the degree of complementarity between consumption and hours. The model is able to match our empirical evidence on the effects of government spending shocks remarkably well. This happens when the preferences are such that the positive wealth effect on labor supply is small and therefore the negative wealth effect on consumption is, somewhat counterintuitively, large.

Keywords: Government spending, markup, private consumption, wealth effect

JEL Classification: D91, E21, E62

Suggested Citation

Monacelli, Tommaso and Perotti, Roberto, Fiscal Policy, Wealth Effects and Markups (December 2008). CEPR Discussion Paper No. DP7099. Available at SSRN: https://ssrn.com/abstract=1344678

Tommaso Monacelli

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Roberto Perotti (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

European University Institute - Economics Department (ECO) ( email )

Villa San Paolo
Via della Piazzuola 43
50133 Florence
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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