Productive Government Expenditure in Monetary Business Cycle Models

Tinbergen Institute Discussion Paper No. TI 2005-053/2

24 Pages Posted: 6 Jun 2005

See all articles by Ludger Linnemann

Ludger Linnemann

University of Cologne - Department of Economics

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 2005

Abstract

This paper assesses the transmission of fiscal policy shocks in a New Keynesian framework where government expenditures contribute to aggregate production. It is shown that even if the impact of government expenditures on production is small, this assumption helps to reconcile the models' predictions about fiscal policy effects with recent empirical evidence. In particular, it is shown that government expenditures can cause a rise in private consumption, real wages, and employment if the government share is not too large and public finance does not solely rely on distortionary taxation. When government expenditures are partially financed by public debt, unit labor costs fall in response to a fiscal expansion, such that inflation tends to decline. Households are willing to raise consumption if monetary policy is active, i.e. ensures that the real interest rate rises with inflation. Otherwise, private consumption can also be crowded-out, as in the conventional case where government expenditures are not productive. The interaction between monetary and fiscal policy is thus decisive for the short-run macroeconomic effects of government expenditure shocks.

Keywords: Productive government expenditures, private consumption, distortionary taxation, monetary and fiscal policy interaction

JEL Classification: E62, E21, E32

Suggested Citation

Linnemann, Ludger and Schabert, Andreas, Productive Government Expenditure in Monetary Business Cycle Models (May 2005). Tinbergen Institute Discussion Paper No. TI 2005-053/2. Available at SSRN: https://ssrn.com/abstract=738385 or http://dx.doi.org/10.2139/ssrn.738385

Ludger Linnemann (Contact Author)

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany
+49-221-470-2999 (Phone)
+49-221-470-5077 (Fax)

Andreas Schabert

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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