The Stabilizing Role of Government Size

33 Pages Posted: 16 May 2007

See all articles by Javier Andrés

Javier Andrés

University of Valencia - Department of Economics

Rafael Doménech

University of Valencia - Department of Economic Analysis

Antonio Fatás

INSEAD; Centre for Economic Policy Research (CEPR); ABFER

Multiple version iconThere are 2 versions of this paper

Date Written: May 16, 2007

Abstract

This paper presents an analysis of how alternative models of the business cycle can replicate the stylized fact that large governments are associated with less volatile economies. Our analysis shows that adding nominal rigidities and costs of capital adjustment to an otherwise standard RBC model can generate a negative correlation between government size and the volatility of output. However, in the model, we find that the stabilizing effect is only due to a composition effect and it is not present when we look at the volatility of private output. Given that empirically we also observe a negative correlation between government size and the volatility of consumption, we modify the model by introducing rule-of-thumb consumers. In this modified version of our initial model we observe that consumption volatility is also reduced when government size increases in similar way to the observed pattern in OECD economies over the last 45 years.

Keywords: government size, output volatility, automatic stabilizers

JEL Classification: E32, E52, E63

Suggested Citation

Andrés, Javier and Doménech, Rafael and Fatas, Antonio, The Stabilizing Role of Government Size (May 16, 2007). Banco de España Research Paper No. WP-0710. Available at SSRN: https://ssrn.com/abstract=986863 or http://dx.doi.org/10.2139/ssrn.986863

Javier Andrés (Contact Author)

University of Valencia - Department of Economics ( email )

E-46022 Valencia, Valencia E-46022
Spain
(34 96) 382 8260 (Phone)
(34 96) 382 8249 (Fax)

Rafael Doménech

University of Valencia - Department of Economic Analysis ( email )

Campus de los Naranjos
46022 Valencia
Spain
+96 382 8210 (Phone)
+96 382 8249 (Fax)

Antonio Fatas

INSEAD ( email )

1 Ayer Rajah Avenue
Singapore, 138676
Singapore
+6567995384 (Phone)

HOME PAGE: http://faculty.insead.edu/fatas

Centre for Economic Policy Research (CEPR)

London
United Kingdom

ABFER ( email )

BIZ 2 Storey 4, 04-05
1 Business Link
Singapore, 117592
Singapore

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