DP8239 Targeted transfers and the fiscal response to the great recession

Author(s): Hyunseung Oh, Ricardo Reis
Publication Date: February 2011
Keyword(s): Fiscal policy, Incomplete markets, Nominal rigidities
JEL(s): e62, h31, h50
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8239

Between 2007 and 2009, government expenditures increased rapidly across the OECD countries. While economic research on the impact of government purchases has flourished, in the data, about three quarters of the increase in expenditures in the United States (and more in other countries) was in government transfers. We document this fact, and show that the increase in U.S. spending on retirement, disability, and medical care has been as high as the increase in government purchases. We argue that future research should focus on the positive impact of transfers. Towards this, we present a model in which there is no representative agent and Ricardian equivalence does not hold because of uncertainty, imperfect credit markets, and nominal rigidities. Targeted lump-sum transfers are expansionary both because of a neoclassical wealth effect and because of a Keynesian aggregate demand effect.