Revisiting the Supply-Side Effects of Government Spending

47 Pages Posted: 6 Apr 2009  

George-Marios Angeletos

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

Vasia Panousi

University of Montreal, Department of Economics

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Date Written: January 2009

Abstract

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

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

George-Marios Angeletos

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Vasia Panousi (Contact Author)

University of Montreal, Department of Economics ( email )

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