Working Paper: CEPR ID: DP7484
Authors: Florin Ovidiu Bilbiie
Abstract: This paper proposes a theoretical explanation of the empirical finding that private consumption increases in response to an increase in government spending. The explanation requires two ingredients. First, labor demand expands (e.g. prices are sticky). Second, general non-separable preferences over consumption and leisure should be such that Frisch labor supply elasticity is lower than the constant-consumption elasticity; this implies that constant-consumption labor supply shifts left. Existing empirical evidence on the relative magnitudes of the two elasticities supports this hypothesis. The parametric conditions under which the result occurs are consistent with restrictions of concavity and non-inferiority of consumption and leisure.
Keywords: Fiscal Policy; Frisch Elasticity of Labor Supply; Government Spending; Nonseparable Preferences; Private Consumption; Sticky Prices
JEL Codes: D11; E21; E62; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government spending (H59) | Private consumption (D19) |
| Government spending (H59) | Labor demand (J23) |
| Labor demand (J23) | Private consumption (D19) |
| Sticky prices (C54) | Labor demand (J23) |
| Nonseparable preferences (D11) | Labor demand (J23) |
| Frisch labor supply elasticity (J49) | Constant-consumption elasticity (D11) |