Paper #911

Title:

Understanding the effects of government spending on consumption

Authors:

Jordi Galí, J. David López-Salido and Javier Vallés

Date:

September 2002 (Revised: August 2005)

Abstract:

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.

Keywords:

Rule-of-thumb consumers, non-Ricardian households, fiscal multiplier, government spending, Taylor rules

JEL codes:

E32, E62

Area of Research:

Macroeconomics and International Economics

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