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Title: A model of the confidence channel of fiscal policy

Author(s): Bernardo Guimarães, Caio Machado and Marcel Ribeiro

Publication Date: August 2014

Keyword(s): aggregate demand, confidence, expectations, fiscal multiplier and fiscal policy

Programme Area(s): International Macroeconomics

Abstract: This paper presents a simple macroeconomic model where government spending affects aggregate demand directly and indirectly, through an expectational channel. Prices are fully flexible and the model is static, so intertemporal issues play no role. There are three important elements in the model: (i) fixed adjustment costs for investment; (ii) noisy idiosyncratic information about the economy; and (iii) imperfect substitution among private goods and goods provided by the government. An increase in government spending raises the demand for private goods and raises firms' expectations about what others will be producing and demanding. The optimal level of government expenditure is larger when the desired level of investment is small, which we interpret as times of low economic activity

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Bibliographic Reference

Guimarães, B, Machado, C and Ribeiro, M. 2014. 'A model of the confidence channel of fiscal policy'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10087