Working Paper: CEPR ID: DP5212
Authors: Jordi Gal; J. David López-Salido; Javier Valls
Abstract: Recent evidence suggests that consumption rises in response to an increase in government spending. That finding cannot be easily reconciled with existing optimizing business cycle models. We extend the standard new Keynesian model to allow for the presence of rule-of-thumb consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.
Keywords: fiscal multiplier; government spending; non-Ricardian households; rule-of-thumb consumers; Taylor rules
JEL Codes: E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government Spending (H59) | Consumption (E21) |
| Government Spending Shock (H69) | Consumption (E21) |
| Government Spending (H59) | Investment (G31) |
| Rule-of-Thumb Consumers + Sticky Prices (C54) | Consumption Response to Government Spending (E20) |