Public consumption over the business cycle

Abstract

What fraction of the business cycle volatility of government purchases is accounted for as endogenous reactions to overall macroeconomic conditions? We answer this question in the framework of a neoclassical representative household model where the provision of a public consumption good is decided upon endogenously and in a time-consistent fashion. A simple version of such a model with aggregate productivity as the sole driving force fails to match important features of the business cycle dynamics of public consumption, which comes out as not as volatile and persistent as in the data and too synchronized with the cycle. We add implementation lags and implementation costs in the budgeting process to the model, plus taste shocks for public consumption relative to private consumption, and achieve a better fit to the data. All these ingredients are essential to improve the fit. In our baseline specification 50% of the variance of public consumption is driven by aggregate productivity shocks.

Polarized Business Cycles

“…Our channel is, however, quite different, since it relies on the degree of polarizarion rather than on the counter-cyclicality of wealth inequality. Bachmann and Bai (2013b) also analyze government consumption over the business cycle, but in a model where the policymaker is subject to taste shocks and implementation lags. Our specifications are related, as a change in ideology could be seen as a taste shock in a static model.…”

“…subject to (9), (10). Here the expectation is taken only over the realization of the TFP shock z. V i and W i are defined as in the text, they are the equilibrium continuation values of remaining in power and losing power, respectively, for a given party of type i.…”

Fiscal Austerity in Ambiguous Times

“…8 This utility function has been used extensively in macroeconomic setups where government consumption provides utility. Klein et al (2008) and Bachmann and Bai (2013) use the case of ρ = ψ = 1. Empirical public finance studies have also used this specification in order to estimate the degree of substitutability between private and government consumption.…”

“…Additional shocks to the utility of government consumption, as in the work ofBachmann and Bai (2013), could potentially generate more variation in the government share. However, this would shift the focus away from ambiguity about the cycle and strain the interpretation -does the agent doubt his own model of preference shocks?21 SeeGuvenen (2006) and references therein for the debate on the size of the IES.22 Interesting work incorporating default risk and fiscal policy considerations is done byCuadra et al (2010), Bi (2012) andArellano and Bai (2016).…”

Macroeconomic policy volatility and household consumption in Africa

“…Leaning empirical credence to the macroeconomic policy volatility and household consumption in Africa could inform policy direction aimed towards the welfare-enhancement of African households facing a prolonged period of hardship. For African households to attain near-optimal consumption level observable in the developed countries, Africa's national and regional governments must ensure predictable, low-level inflation; even, investment-friendly interest rate; trade diversification built on credible export promotion strategies; robust fiscal policies; and an internationally competitive and reasonable real exchange rate (Bachmann and Bai 2013;Fatás et al 2001;Lucas 2003). Strong and stable macroeconomic policies induce higher levels of investment and sustainable growth, which, in turn, positively influences household final consumption expenditure through increased labour income realisation capable of augmenting aggregate demands (Chirwa and Odhiambo 2016).…”