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.
ASJC Scopus subject areas
- Economics and Econometrics