Can public spending boost private consumption?

Abstract

One of the most debated issues in modern macroeconomics relates to the behaviour of private consumption in response to an increase in government spending. Recent empirical studies have found a positive relationship between these two macroeconomic fundamentals. However, such a finding cannot be easily reconciled with simple real business cycle models. In this paper, we develop and estimate a new Keynesian model that is able to predict a rise in consumption in response to an increase in productive public spending. We show the two key elements that lead to a statistically significant positive reaction of private consumption, thereby creating consumption present-value multipliers, are: (i) a productive component in public spending and (ii) nominal rigidities. Our key results remain valid to various robustness checks that include a sub-sample analysis examining the pre-Great Recession period and a sensitivity analysis on the structural, fiscal and monetary policy parameters of the model.Résumé. La dépense publique peut-elle stimuler la consommation des ménages? En macroéconomie moderne, l'une des questions les plus débattues concerne les comportements de consommation des ménages consécutifs à une augmentation des dépenses gouvernementales. De récentes études empiriques ont établi une relation positive entre ces deux fondamentaux macroéconomiques. Néanmoins, il reste difficile de concilier de

The impact of unprecedented growth in public investment on stimulating the Indian economy

“…As a consequence, when maximising utility, households take into account the level of public consumption, because this type of government spending is partly a substitute for private consumption (Asimakopoulos et al, 2021). Conversely, public investment is not included in the household utility function, because it is not a substitute for private consumption.…”

“…Firstly, public investment affects public capital, and as a consequence increases the productive capacity of the economy, whereas public consumption does not affect the production function (Baxter and King, 1993;Kamps, 2004;Bom and Ligthart, 2014;Dinlersoz and Fu, 2020). Secondly, public investment, unlike public consumption, is not a substitute for private consumption, which leads to weaker crowding-out of private consumption (Karras, 1994;Kwan, 2006;Ercolani and Azevedo, 2014;Ambler et al, 2017;Asimakopoulos et al, 2021).…”

The consumption multiplier of government spending: the role of substitutability between government spending and leisure

“…2 In contrast, Linnemann (2006) considers non-separable utility function between consumption and leisure and shows that the consumption multiplier can be positive when consumption and government spending are substitutes in a frictionless business cycle model for a certain functional form of preferences. However, Bilbiie (2009) shows that, for general utility function, the parameter restriction under which a positive consumption multiplier occurs in a frictionless business cycle model implies that either the utility function is not concave or that 1 These modifications include productive government spending (Baxter and King (1993); Asimakopoulos, Lorusso, and Pieroni (2021)), hand-to-mouth households (Galí, López-Salido, and Vallés (2007)), deep habit (Ravn, Schmitt-Grohé, and Urbe (2006)), and others.…”