Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets

32 Pages Posted: 27 Jun 2007 Last revised: 17 Jul 2007

See all articles by George-Marios Angeletos

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

Multiple version iconThere are 2 versions of this paper

Date Written: May 2007

Abstract

This paper revisits the macroeconomic effects of government consumption in the neoclassical growth model augmented with idiosyncratic investment (or entrepreneurial) risk. Under complete markets, a permanent increase in government consumption has no long-run effect on the interest rate, the capital-labor ratio, and labor productivity, while it increases work hours due to the familiar negative wealth effect. These results are upset once we allow for incomplete markets. The very same negative wealth effect now causes a reduction in risk taking and investment. This in turn leads to a lower risk-free rate and, under certain conditions, also to a lower capital-labor ratio, lower productivity and lower wages.

Suggested Citation

Angeletos, George-Marios and Panousi, Vasia, Revisiting the Supply-Side Effects of Government Spending Under Incomplete Markets (May 2007). NBER Working Paper No. w13136. Available at SSRN: https://ssrn.com/abstract=989947

George-Marios Angeletos (Contact Author)

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

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Vasia Panousi

University of Montreal, Department of Economics ( email )

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