Working Paper: CEPR ID: DP4384
Authors: Javier Andrés; Rafael Domenech; Antonio Fatás
Abstract: This Paper presents an analysis of how alternative models of the business cycle can replicate the stylized fact that large governments are associated with less volatile economies. Our analysis shows that adding nominal rigidities and costs of capital adjustment to an otherwise standard RBC model can generate a negative correlation between government size and the volatility of output. In the model, however, we find that the stabilizing effect is only due to a composition effect and it is not present when we look at the volatility of private output. Given that empirically we also observe a negative correlation between government size and the volatility of consumption, we modify the model by introducing rule-of-thumb consumers. In this modified version of our initial model we observe that consumption volatility is also reduced when government size increases.
Keywords: Automatic Stabilizers; Government Size; Output Volatility
JEL Codes: E32; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government size (H11) | output volatility (E23) |
| government size (H11) | private consumption volatility (D19) |
| government size (H11) | investment volatility (G17) |
| government size (H11) | stable non-volatile component of GDP (E20) |
| rule-of-thumb consumers (D11) | consumption volatility (E20) |