Working Paper: CEPR ID: DP10087
Authors: Bernardo Guimares; Caio Machado; Marcel Ribeiro
Abstract: This paper presents a simple macroeconomic model where government spending affects aggregate demand directly and indirectly, through an expectational channel. Prices are fully flexible and the model is static, so intertemporal issues play no role. There are three important elements in the model: (i) fixed adjustment costs for investment; (ii) noisy idiosyncratic information about the economy; and (iii) imperfect substitution among private goods and goods provided by the government. An increase in government spending raises the demand for private goods and raises firms' expectations about what others will be producing and demanding. The optimal level of government expenditure is larger when the desired level of investment is small, which we interpret as times of low economic activity
Keywords: aggregate demand; confidence; expectations; fiscal multiplier; fiscal policy
JEL Codes: E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in government spending (H59) | Raises demand for private goods (D12) |
| Increase in government spending (H59) | Enhances firms' expectations about production and demand (D25) |
| Enhances firms' expectations about production and demand (D25) | Firms decide to invest (G31) |
| Increase in government spending (H59) | Firms decide to invest (G31) |
| Low expected demand (R22) | Firms decide against investing (G31) |
| Increase in government spending (H59) | Shifts expectations (D84) |