DP5212 Understanding the Effects of Government Spending on Consumption

Author(s):	Jordi Galí, J David López-Salido, Javier Vallés Liberal
Publication Date:	September 2005
Keyword(s):	fiscal multiplier, government spending, non-Ricardian households, rule-of-thumb consumers, Taylor rules
JEL(s):	E32, E62
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=5212

Recent evidence suggests that consumption rises in response to an increase in government spending. That finding cannot be easily reconciled with existing optimizing business cycle models. We extend the standard new Keynesian model to allow for the presence of rule-of-thumb consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.