47 Pages Posted: 6 Apr 2009
Date Written: January 2009
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.
Keywords: Fiscal policy, government spending, incomplete risk sharing, entrepreneurial risk
JEL Classification: E13, E62
Suggested Citation: 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: https://ssrn.com/abstract=1370451 or http://dx.doi.org/10.2139/ssrn.1370451